Corporate bond market momentum: a model

September 3, 2016

An increase in expected default ratios naturally reduces prices for corporate bonds. However, it also triggers feedback loops. First, it reduces funds’ wealth and demand for corporate credit in terms of notional, resulting in selling for rebalancing purposes. Second, negative performance of funds typically triggers investor outflows, resulting in selling for redemption purposes. Flow-sensitive market-making and momentum trading can aggravate these price dynamics. A larger market share of passive funds can increase tail risks.

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The threat from China’s shadow finance

August 27, 2016

In past years China witnessed a boom in shadow finance, particularly in form of entrusted loans. Banks apparently used shadow credit products in large size to circumvent policy restrictions and bank loan regulations. Regulatory tightening has reined in the proliferation of shadow finance since 2014, but outstanding contracts pose serious systemic risk due to the combination of high default risk and dependence on fragile wholesale funding.

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The world’s negative term premium

August 20, 2016

The term premium on the “world government bond yield” has turned decisively negative, according to BIS research. Investors have since 2014 accepted a long-term yield below expected short-term rates, rather than charging a premium on duration exposure. The compression and inversion of term premia may have been fueled by a global duration carry trade and seems to be a global phenomenon. It has coincided with increased correlation of long-term yields across developed and emerging markets.

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The importance of differentiating types of oil price shocks

August 13, 2016

To assess the consequences of an oil price shock for markets it is important to identify its type. A new method separates oil supply shocks, oil market-specific demand shocks and global growth shocks. Supply shocks have accounted for about 50% of price volatility since the mid-1980s. Oil market-specific shocks drive a wedge between the growth of developed and emerging economies and hence matter for exchange rate trends. Global demand shocks to oil prices do not cause such a divergence.

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Fed policy shocks and foreign currency risk premia

August 5, 2016

A new Federal Reserve paper suggests that non-conventional monetary policy easing “shocks” not only push foreign currencies higher versus the U.S. dollar, but also reduce the risk premia on foreign-currency cash and bonds. Non-conventional easing shifts the options-implied skewness of risk from dollar appreciation to depreciation, due partly to diminishing U.S. dollar funding pressure. The effects appear to be temporary, though.

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The side-effects of non-conventional monetary policy

July 30, 2016

A BIS summary of research gives a nice overview on non-conventional monetary policies and their unintended systemic consequences. Current policies appear to yield diminishing returns in terms of easier financial conditions, while their costs and side effects are increasing. This leaves markets more exposed to future negative shocks. Also, the descent into negative nominal interest rates is itself a drag on profitability and health of the financial system that erodes the effectiveness of non-conventional policies.

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Sticky expectations and predictable equity returns

July 23, 2016

New research documents that company earnings expectations of analysts have historically been sticky, plausibly reflecting that it takes time and effort to update forecasts. Such stickiness can explain two important anomalies of stock returns: price momentum and outperformance of high-profitability stocks. Indeed, these two anomalies have been correlated and stronger for stocks where analyst expectations have been stickier.

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Trend following as tail risk hedge

July 18, 2016

Typical returns of a trend following strategy carry features of a “long vol” position and have positive convexity. Typical returns of long only strategies, such as risk parity, rather exhibit a “short vol” profile and negative convexity. This makes trend following a useful complement of long-only portfolios, by mitigating tail risks that manifest as escalating trends. Options are naturally a cleaner hedge for tail risk, but have over the past two decades been prohibitively expensive.

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The illiquidity risk premium

July 16, 2016

The illiquidity risk premium is an excess return paid to investors for tying up capital. The premium compensates the investor for forfeiting the options to contain mark-to-market losses and to adapt positions to a changing environment. A brief paper by Willis Towers Watson presents an approach to measure the illiquidity risk premium across assets. The premium appears to be time-variant and highest during and pursuant to financial crises.

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FX strategies based on real exchange rates

July 9, 2016

New empirical research provides guidance as to how to use real exchange rates for currency strategies. First, real exchange rates can serve as a basis for value-based strategies, but only if they are adjusted for key secular structural factors, such as productivity growth and product quality. Second, real exchange rates in conjunction with macroeconomic indicators can serve as indicators for the risk premia paid on currency positions.

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Macrosynergy is a London based macroeconomic research and technology company whose founders have developed and employed macro quantamental investment strategies in liquid, tradable asset classes, across many markets and for a variety of different factors to generate competitive, uncorrelated investment returns for institutional investors for two decades. Our quantitative-fundamental (quantamental) computing system tracks a broad range of real-time macroeconomic trends in developed and emerging countries, transforming them into macro systematic quantamental investment strategies. In June 2020 Macrosynergy and J.P. Morgan started a collaboration to scale the quantamental system and to popularize tradable economics across financial markets.

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