Term structure of recession probabilities and the cross section of asset returns
Speaker: Dr. Ti Zhou (Southern University of Science and Technology)
?Term structure of recession probabilities and the cross section of asset returns
? 10:30am-12:00pm, 2018/3/30
? Room A619, Teaching A
? Dr. Ti Zhou (Southern University of Science and Technology)?
The duration of business cycles changes over time, generating time-varying investor concern about recessions. I study a new macro-factor model that links assets’ risk premia to such concern, directly measured by the term structure of recession probabilities from professional forecasters. The innovation to the slope of the term structure is negatively priced with economically large risk premiums in a wide range of tests assets, consistent with how the slope predicts long-horizon economic activity and labor income growth. A recession risk model, including market and the innovation to the slope, explains more than half of the variation of average excess returns on portfolios sorted on size, book-to-market, and asset growth.
The factor mimicking portfolios of the model help reconcile the joint cross section of returns on equity index options and currencies, and have performance comparable to several multi factor benchmarks. My evidence suggests that the slope of the term structure is a recession state variable (Cochrane, 2005, Chapter 9), and an economic source of risk premia on test assets can be attributed to time-varying investor concern over future recessions that is priced.