Working Paper: CEPR ID: DP14115
Authors: Alan M. Taylor; Josh Davis
Abstract: Research finds strong links between credit booms and macroeconomic outcomes like financial crises and output growth. Are impacts also seen in financial asset prices? We document this robust and significant connection for the first time using a large sample of historical data for many countries. Credit boom periods tend to be followed by unusually low returns to equities, in absolute terms and relative to bonds. Return predictability due to this leverage factor is distinct from that of established factors like momentum and value and generates trading strategies with meaningful excess profits out-of-sample. These findings pose a challenge to conventional macro-finance theories.
Keywords: debt; leverage; cycles; asset pricing; return predictability; asset allocation
JEL Codes: E17; E20; E21; E32; E44; G01; G11; G12; G17; G21; N10
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| credit boom periods (E32) | lower future equity returns (G12) |
| higher credit growth (E51) | lower future equity returns (G12) |
| leverage factor (d3credgdp) (F62) | lower future equity returns (G12) |
| leverage factor (d3credgdp) (F62) | improve portfolio performance metrics (G11) |
| credit boom periods (E32) | lower future bond returns (G12) |