MONIA MAGNANI

We study whether and how monetary policymakers may have contributed to inflate asset price bubbles and in general what are the potentially complex, nonlinear linkages between short-term policy rates and the size and expected durations of equity bubbles. In particular, we extend empirical models of periodically collapsing, rational bubbles to test whether and to what extent the long cycle of rates at the zero lower bound and of quantitative easing policies may have increased the probability of bubbles inflating and persisting, with special emphasis on the US stock market. We find that the linkages between S&P returns and rate-based indicators of monetary policies contain evidence of recurring regimes that can be characterised as one of a persisting vs. one of a collapsing bubble. Moreover, the probabilities of financial markets transitioning from a bubble to a state of (partial) collapse turns out to depend on both the initial, relative size of the bubble and on monetary policy indicators. This implies that an easier (tighter) monetary policy will inflate (deflate) a bubble through a simple, regression-style effect, but also yield a non-linear," concave" effect by which sufficiently low (high) rates are enough for a bubble to inflate (deflate) with high probability. Besides fitting the data, the resulting, parsimonious, regime switching models provide an accurate and economically valuable predictive performance, even when transaction costs are taken into account.

Can Monetary Policies Inflate a Stock Market Bubble? A Regime Switching Model of Periodically Collapsing Bubbles by Monia Magnani :: SSRN

The academic literature has amassed overwhelming evidence indicating that investment opportunities are hardly driven in a simplistic way by business cycle conditions, when measured by standard macroeconomic aggregates (such as the output gap and inflation). Yet, an industry exists that routinely forecasts business cycle conditions and the policy measures routinely used to manage the length and persistence of recessions and expansions. In this paper, we ask whether standard macroeconomic variables such as measures of output and effective policy interest rates may lead to risk-adjusted economic value to an already well-diversified, risk-averse investor who selects how much of her wealth to allocate to a range of common hedge fund strategies, including hedge funds as a whole. We find that while both the inclusion of hedge funds and the modelling of macro-driven predictability patterns in asset risk premia can generate non-negligible economic value in recursive, out-of-sample portfolio back-testing exercises. Such effects are maximised when hedge fund strategies are available to exploit the forecasting power of macroeconomic predictors.

Does Macroeconomic Predictability Enhance the Economic Value of Hedge Funds to Risk-Averse Investors?  by Monia Magnani :: SSRN

Using univariate and (independent and dependent) double sorting methods applied to the cross-section of US stock returns we test whether bubble risk is priced, whether the shocks in Federal funds shadow rate are priced and whether the latter shock to the stance of monetary policy exercise an effect on the materiality and strength of bubble risk. We find that bubble risk is priced even though this occurs to a rather peculiar “tent-shaped” decile portfolio spread that goes long in intermediate deciles characterised by small or modest exposure and that goes short in deciles implying extreme exposures, both negatively and positively signed. On the opposite, taken in isolation, monetary policy risk fails to be priced in the cross-section. Finally, the shadow rate shocks render bubble shocks irrelevant as a risk factor when conditional double sorting is applied (we first sort stocks into deciles based on their exposure to monetary policy shocks and then in deciles based on bubble shocks). Instead, when an independent double sorting is applied, bubble shock risk appears to be heavily mediated by the exposure of stocks to monetary policy risk, in the sense that only stocks characterised by low exposure to the latter preserve the exposure to the bubble risk “tent-shaped” factor isolated when monetary policy is ignored.