The Decline in Asset Return Predictability and Macroeconomic Volatility
Francisco J. Palomino and
No 2017-050, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (US)
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.
Keywords: Asset return predictability; Great Moderation; Monetary policy; Time-varying macroeconomic volatility (search for similar items in EconPapers)
JEL-codes: E14 E44 G12 G18 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fmk and nep-mac
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