Jason Thomas

Much of the existing literature misunderstands “reach for
yield” behavior as an increase in risk-taking in response to low
interest rates. By focusing on common stocks – where dividend
yields are inversely related to systematic risk – I demonstrate
that “reach for yield” instead reflects an increase in the
marginal utility of current income in response to low interest
rates. The monthly returns of a long-short portfolio that buys
the highest-yielding 10% of stocks and sells… Show more

Much of the existing literature misunderstands “reach for
yield” behavior as an increase in risk-taking in response to low
interest rates. By focusing on common stocks – where dividend
yields are inversely related to systematic risk – I demonstrate
that “reach for yield” instead reflects an increase in the
marginal utility of current income in response to low interest
rates. The monthly returns of a long-short portfolio that buys
the highest-yielding 10% of stocks and sells the lowest-yielding
decile increase by 1.4% for every 1% decline in two-year
interest rates. These effects are three times as large when
the decline in interest rates is attributable to a fall in the term premium, which suggests unconventional monetary policies
may generate especially large increases in the marginal utility
of current income. By increasing the market value of current
income relative to future returns, unconventional policy may
lead corporate managers to boost shareholder distributions at
the expense of capital accumulation. Show less

By sapping confidence and depressing bank capital levels, unconventional monetary policy may create costs that exceed its modest benefits. The September shift in Bank of Japan (BOJ) policy and ongoing concerns about European banks could pave the way for a broader rethink of monetary stimulus. Policymakers may focus increasingly on the steepness of the term structure rather than the absolute level of longer-term interest rates.

Despite record low interest rates, business investment has been weaker this expansion than any other in the past 50 years. This puzzle may be explained, in part, by investors’ tendency to respond to low rates by diversifying into dividend-paying stocks and other “yield products” to boost portfolio income. Over the past forty years, every 1% decline in real rates has boosted the monthly return of high-yield stocks by 1.4% relative to low-yield stocks, with evidence of larger effects since… Show more

Despite record low interest rates, business investment has been weaker this expansion than any other in the past 50 years. This puzzle may be explained, in part, by investors’ tendency to respond to low rates by diversifying into dividend-paying stocks and other “yield products” to boost portfolio income. Over the past forty years, every 1% decline in real rates has boosted the monthly return of high-yield stocks by 1.4% relative to low-yield stocks, with evidence of larger effects since 2010. By increasing the market value of current income relative to long-lived capital, low rates may create financial incentives for corporate managers to distribute incremental cash flow through dividends and share repurchases rather than reinvest it in their business. While this phenomenon serves, at best, as a partial explanation for the slow growth in investment and productivity, it does suggest that the real economy’s vulnerability to rising interest rates may not be as acute as many fear. Show less

Much of the existing literature misunderstands “reach for yield” behavior as an increase in risk-taking in response to low interest rates. By focusing on common stocks – where dividend yields are inversely related to systematic risk – I demonstrate that “reach for yield” instead reflects an increase in the marginal utility of current income relative to expected holding period returns. The monthly returns of the highest yielding 10% of stocks increase by 0.76% for every 1% decline in two-year… Show more

Much of the existing literature misunderstands “reach for yield” behavior as an increase in risk-taking in response to low interest rates. By focusing on common stocks – where dividend yields are inversely related to systematic risk – I demonstrate that “reach for yield” instead reflects an increase in the marginal utility of current income relative to expected holding period returns. The monthly returns of the highest yielding 10% of stocks increase by 0.76% for every 1% decline in two-year interest rates, after controlling for known risk factors. The monthly returns of a long-short portfolio that buys the highest-yielding 10% of stocks and sells the lowest-yielding decile increase by 1.4% for every 1% decline in two-year interest rates. These effects are three-times as large when the decline in interest rates is attributable to a fall in the term premium, which suggests unconventional monetary policies may generate especially large increases in the marginal utility of current income. By increasing the market value of current income relative to future returns, unconventional policy may lead corporate managers to boost shareholder distributions at the expense of capital accumulation.
Show less

The experience of the last twelve months suggests that
oil prices can be too low as well as too high. The Fed may
not pursue further rate hikes in 2016 unless oil moves up
towards a “Goldilocks” price that is neither “too hot,” so
as to choke-off demand, nor “too cold” so as to cancel
energy development projects and increase stresse in the
financial system.

Abstract
Although investors spend considerable time and effort forecasting economic fundamentals, most of the variation in asset prices is explained by shifts in the discount rates applied to future cash flows. Discount rates evolve through time in response to changes in investors’ risk perceptions and risk tolerance. Measures of conditional volatility, like the VIX index, are a function of investors’ hedging demand and provide a reliable, real-time proxy for the price of risk. When the… Show more

Abstract
Although investors spend considerable time and effort forecasting economic fundamentals, most of the variation in asset prices is explained by shifts in the discount rates applied to future cash flows. Discount rates evolve through time in response to changes in investors’ risk perceptions and risk tolerance. Measures of conditional volatility, like the VIX index, are a function of investors’ hedging demand and provide a reliable, real-time proxy for the price of risk. When the conditional volatility of an asset increases, its expected return must rise, which requires the price of the asset to decline today. This mechanism generates the observed negative contemporaneous correlation between returns and conditional volatility, as well as the positive correlation between current measures of conditional volatility and future returns. The paper demonstrates that the VIX index explains over three-quarters of the variation in broad stock market price-to-earnings ratios, two-thirds of the variation in next twelve months’ returns on the S&P 500, and over four-fifths of the monthly variation in the option-adjusted spread on B-rate corporate bonds. These results make clear that measures of conditional volatility provide important information about expected returns that can be used as the basis for portfolio construction and time-varying allocation strategies. Show less

I demonstrate that much of the time series variation in the credit spread on high yield bonds is attributable to changes in the “credit risk premium” rather than changes in expected default losses. The credit risk premium is the expected excess return investors earn from bearing default risk after controlling for expected losses, liquidity, and other factors. I find that the credit risk premium on high yield bonds averages about 2.4% per year, accounts for 43% of high yield credit spreads, on… Show more

I demonstrate that much of the time series variation in the credit spread on high yield bonds is attributable to changes in the “credit risk premium” rather than changes in expected default losses. The credit risk premium is the expected excess return investors earn from bearing default risk after controlling for expected losses, liquidity, and other factors. I find that the credit risk premium on high yield bonds averages about 2.4% per year, accounts for 43% of high yield credit spreads, on aver-
age, and predicts excess returns on high yield bonds. I also find that the excess returns on lower rated credits (B and CCC, relative to BB) are more sensitive to variation in the credit risk premium. The credit risk premium increases with the conditional volatility of default losses and decreases with aggregate consumption growth. The evidence suggests that conventional measures of economic risk are able to explain the sizable increase in credit spreads in the fall of 2008. Show less

The search for deeper meaning in the People’s Bank of China (PBOC) decision to devalue the renminbi (RMB) is understandable given concerns about the quality of official economic data and the opacity of government decision-making. The simple fact is that China is in the midst of a multi-year slowdown that has been exacerbated by sharp real exchange rate appreciation over the past year. The RMB devaluation and accompanying currency reforms are a rational response to these problems. Given… Show more

The search for deeper meaning in the People’s Bank of China (PBOC) decision to devalue the renminbi (RMB) is understandable given concerns about the quality of official economic data and the opacity of government decision-making. The simple fact is that China is in the midst of a multi-year slowdown that has been exacerbated by sharp real exchange rate appreciation over the past year. The RMB devaluation and accompanying currency reforms are a rational response to these problems. Given China’s importance to global growth, the Chinese government’s efforts to reflate the econ¬omy should be wel¬comed, and neither viewed as a provocation or a sign of deeper malaise. Sometimes a cigar is just a cigar; investors should beware of reading too deeply into the devaluation, or seeking more elaborate narratives to explain it. Show less