Finance and Economics Discussion Series (FEDS)

Twitter Share RSS

May 2017

The Decline in Asset return Predictability and Macroeconomic Volatility

Alex Hsu, Francisco Palomino, and Charles Qian

Abstract:

We document strong U.S. stock and bond return predictability from several macroeconomic volatility series before 1982, and a significant decline in this predictability during the Great Moderation. These findings are robust to alternative empirical specifications and out-of-sample tests. We explore the predictability decline using a model that incorporates monetary policy and shocks with time-varying volatility. The decline is consistent with changes in both policy and shock dynamics. While an increase in the response to inflation in the interest-rate policy rule decreases volatility, more persistent and less volatile shocks explain the lower predictability.

Accessible materials (.zip)

Keywords: Asset return predictability, Great Moderation, Monetary policy, Time-varying macroeconomic volatility

DOI: https://doi.org/10.17016/FEDS.2017.050

PDF: Full Paper

Back to Top
Last Update: January 09, 2020