# MASSIMO GUIDOLIN

## Working papers

MASSIMO GUIDOLIN and M. Pedio

BAFFI CAREFIN Centre Research Paper No. 2019-117.

This paper has a twofold objective. First, we contribute to the stream of literature that investigates whether traditional asset pricing factors show any predictive power for the cross-section of Real Estate Investment Trust (REIT) returns. In particular, we investigate the existence of a premium associated to the Value, Size, Momentum, Investment, and Profitability factors over the period 1993-2018. We find support for all the pricing factors but for the Profitability one. Second, we investigate whether a set of smart beta strategies, based on the combination of the identified factors, may outperform similar allocation techniques that do not exploit factors. We find that all the proposed factor-based strategies display a higher risk-adjusted out-of-sample performance than a simple buy-and-hold investment in the real estate market (proxied by the FTSE NAREIT All REITs Index). In addition, we find that when factor-based strategies are implemented, REIT-only portfolios display risk-adjusted performances comparable to those of diversified portfolios that include equity, bond, and commodities.

Sentiment Risk Premia in the Cross-Section of Global Equity and Currency Returns

MASSIMO GUIDOLIN, R. Fuess, and C. Koeppel

BAFFI CAREFIN Centre Research Paper No. 2019-116.

This paper introduces a new sentiment-augmented asset pricing model in order to provide a comprehensive understanding of the role of non-fundamental risk factors. We find that news and social media search-based indicators that measure the aggregate investor sentiment are significantly related to excess returns across different asset classes and markets. Adding sentiment factors to both classical and more recent state-of-the-art pricing models leads to a significant increase in model performance. Following a two-stage Fama-MacBeth procedure, our modified pricing model obtains positive estimates of the risk premium for negative sentiment for global equity markets. We interpret them as measures of additional market uncertainty not captured by standard risk factors. Negative sentiment captures investors' fear, for which they demand an additional risk premium on sentiment-sensitive assets. Consequently, our empirical results contribute to the explanation of the cross-section of average, international excess equity and foreign exchange returns.

Does the Cost of Private Debt Respond to Monetary Policy? Heteroskedasticity-Based Identification in a Model with Regimes

GUIDOLIN MASSIMO, V. Massagli, and M. Pedio

BAFFI CAREFIN Centre Research Paper No. 2019-118.

We investigate the effects of a conventional monetary expansion, the quantitative easing, and maturity extension programs on the yields of corporate bonds. We adopt a multiple-regime VAR identification based on heteroskedasticity. An impulse response function analysis shows that a traditional, rate based expansionary policy leads to an increase in yields. The response to quantitative easing is instead a general and persistent decrease, in particular for long-term bonds. The responses generated by the maturity extension program are significant and of larger magnitude. A decomposition shows that the unconventional programs reduce the cost private debt primarily through a reduction in risk premia.

A Markov Switching Cointegration Analysis of the CDS-Bond Basis Puzzle

MASSIMO GUIDOLIN, F. Melloni, and M. Pedio

BAFFI CAREFIN Centre Research Paper No. 2019-121.

We investigate the long-run equilibrium relationship between credit default swap (CDS) premia and bond spreads for 65 U.S. corporate entities and 6 major banks over the period April 2011 – February 2018. Standard regression methods reveal that in 40 out of 71 entities, the two series fail to be cointegrated, which is puzzling because it represents a violation of the efficient market hypothesis. Differently from the previous literature, we estimate a Markov switching vector error correction model to capture the fact that regimes may be characterize the adjustment mechanism and the short-term dynamics between the spread series. We use this framework to investigate how the two markets contribute to the price discovery of credit risk. We find that there are many entities that switch between a regime where the adjustment to the long-run cointegrating relationship does not take place and a regime where one between the CDS or the bond markets leads the price discovery. Finally, we investigate whether the industry or other firm characteristics, such as the rating, the leverage, and the capital structure, may be relevant to determine which of the two markets is leads in the price discovery process.

Can Investors Benefit from Hedge Fund Strategies? Utility-Based, Out-of-Sample Evidence

MASSIMO GUIDOLIN and A. Orlov

BAFFI CAREFIN Centre Research Paper No. 2018-87.

We report systematic, out-of-sample evidence on the benefits to an already well diversified investor that may derive from further diversification into various hedge fund strategies. We investigate dynamic strategic asset allocation decisions that take into account investors’ preferences as well as return predictability. Our results suggest that not all hedge fund strategies benefit a long-term investor who is already well diversified across stocks, government and corporate bonds, and REITs. Only strategies whose payoffs are highly nonlinear (e.g., fixed income relative value and convertible arbitrage), and therefore not easily replicable, constitute viable options. Most of the realized economic value fails to result from a mean-variance type of improvement but comes instead from an improvement in realized higher-moment properties of optimal portfolios. Medium to highly risk-averse investors benefit the most from this alternative asset class.

Monetary Policy after the Crisis: Threat or Opportunity to Hedge Funds' Alphas?

MASSIMO GUIDOLIN, A. Berglund, and M. Pedio

BAFFI CAREFIN Centre Research Paper No. 2018-84.

We examine the effects of U.S. monetary policy announcements during and after the Great Financial Crisis on the average abnormal returns (the “alpha”) of the hedge fund industry as a whole and of a range of hedge strategy indices. We apply a variety of tests of increasing sophistication including simple event studies, formal tests for breaks, and Markov switching models. The event studies show that both the overall index and longshort equity and fixed income arbitrage hedge strategies were systematically affected by unexpected monetary policy announcements while other strategies appear to have been less impacted. Formal break point tests show that for all but one strategies as well as the overall index, there is evidence of five breakpoints. For the overall index and most of the sub-indices many of the endogenously determined breaks closely match a list of policy surprise dates that have been already singled out because they had strongly affected financial markets in general. Especially for the long-short equity, fixed income arbitrage, dedicated short-bias, and global macro hedge funds, there is a significant tendency for estimated alphas decline over time, following policy surprises.

Forecasting Commodity Futures Returns: An Economic Value Analysis of Macroeconomic vs. Specific Factors

MASSIMO GUIDOLIN and M. Pedio

BAFFI CAREFIN Centre Research Paper No. 2018-86.

We test whether three well-known commodity-specific variables (basis, hedging pressure, and momentum) may improve the predictive power for commodity futures returns of models otherwise based on macroeconomic factors. We compute recursive, out-of-sample forecasts for fifteen monthly commodity futures return series, when estimation is based on a stepwise regression approach under a probability-weighted regime-switching regression that identifies different volatility regimes. Comparisons with an AR(1) benchmark show that the inclusion of commodity-specific factors does not improve the forecasting power. We perform a back-testing exercise of a meanvariance investment strategy that exploits any predictability of the conditional risk premium of commodities, stocks, and bond returns, also taking into account transaction costs caused by portfolio rebalancing. The risk-adjusted performance of this strategy does not allow us to conclude that any forecasting approach outperforms the others. However, there is evidence that investment strategies based on commodity-specific predictors outperform the remaining strategies in the high-volatility state.