Download - Reaching for yield
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Reaching for Yield
Yichuan Wang
Michigan Interactive InvestmentsUniversity of Michigan
April 7, 2013
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Outline
IntroductionReaching for YieldCAPM
Empirical Data and ResultsJournal ArticlesRegression Data
ConclusionsStrategyFuture Work
References
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Outline
IntroductionReaching for YieldCAPM
Empirical Data and ResultsJournal ArticlesRegression Data
ConclusionsStrategyFuture Work
References
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Reaching for YieldI When rates of return are low, people go into riskier assetsI Imagine you are a pension manager
I You need to get 3% yield, but Interest rates are very low
Figure: Bond Yields
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Choice of AssetsI One potential solution: risker stocks – better to go for broke
than to get fired
0.0
0.1
0.2
0.3
0.4
−5 0Return
Figure: Return Distributions
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Tangent – CAPM
I Basic idea: risk compensated by returnI Risk: Market BetaI Return: Alpha
I Standard CAPM:ri ∼ αi + βi rm
I Beta (βi ) – measure of volatility, used to indicate risk, but notperfect
I Example: Deep out of the money putsI But is sufficient for a short term measure of ’reaching for yield’
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Example With McDonalds
−0.050
−0.025
0.000
0.025
0.050
−0.050 −0.025 0.000 0.025 0.050SPY
MC
D
2007
2008
2009
2010
2011
2012
2013Year
Figure: MCD vs. SPY Daily Returns
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Example with McDonalds
−0.0050
−0.0025
0.0000
0.0025
0.0050
−0.0050 −0.0025 0.0000 0.0025 0.0050SPY
MC
D
2007
2008
2009
2010
2011
2012
2013Year
Figure: Return Scatterplot – Alpha is the Y-Intercept
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Outline
IntroductionReaching for YieldCAPM
Empirical Data and ResultsJournal ArticlesRegression Data
ConclusionsStrategyFuture Work
References
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Insurance Portfolios
I Prevalent in corporate bond market - Abstract from Beckerand Ivashina [2013]
...insurance portfolios are systematically biased towardhigher yield, higher CDS bonds. Reaching-for-yield ... isalso more pronounced for firms with poor corporategovernance and for which regulatory capital requirementis more binding. A comparison of the ex-post performanceof bonds acquired by insurance companies shows nooutperformance, but higher systematic risk and volatility.
I Matches theory:
1. Poor corporate governance and binding capital makes ’goingfor broke’ more attractive
2. Negative sum game – higher risk and volatility
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Stock Prices and Portfolio StrategyI Suggests high beta stocks will earn lower risk-adjusted returns
when credit is easyI Risk-adjusted is important – helps filter out the noise from
market returnsI Easy credit allows firms to lever up to pursue these high risk
strategies
I Betting against beta factor Frazzini and Pedersen [2010]
We test the model’s predictions within U.S. equities,across 20 global equity markets, for Treasury bonds,corporate bonds, and futures. Consistent with the model,we find in each asset class that a betting-against-beta(BAB) factor which is long a leveraged portfolio oflow-beta assets and short a portfolio of high-beta assetsproduces significant risk-adjusted returns. When fundingconstraints tighten, betas are compressed towards one,and the return of the BAB factor is low.
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Portfolio Performance
Figure: Monthly Alpha (Percent) for Portfolios Sorted into Beta Deciles
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Dependence on Funding Conditions
Figure: Frazzini and Pedersen [2010] BAB Regressions
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Stock Price Regressions
I We can see effects of ’Betting against Beta’ in a simpleregression!
I Take price history of almost all stocks traded on US exchangesfrom available price data from 2007 – Present
I Comprise ∼100% of total market capitalization
I Weight regressions by market capitalization, use robustregression (Huber M-Estimator)
I Specification:
1. Standard CAPM:ri ∼ αi + βi rm
2. Betting Against Beta (b):
αi ∼ a + b |βi |
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Data Source
I ’Yahoo Finance’, interfaced through open source R:I Quantmod, TTR, ggplot2
Figure: Console Output of Code
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Yearly Results
−0.20
−0.15
−0.10
−0.05
0.00
0.05
2007 2008 2009 2010 2011 2012
Bet
a C
oeffi
cien
t
Reaching for Yield?
Figure: Coefficient (b) for 2007 – 2012
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Sorted by Market Capitalization
−0.3
−0.2
−0.1
0.0
0.1
0.2
2007 2008 2009 2010 2011 2012
Bet
a C
oeffi
cien
t
0.010
0.015
0.020
0.025
0.030BetaSE
Market Cap
Small
Medium
Large
Reaching for Yield?
Figure: Divided by Market Capitalization
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Outline
IntroductionReaching for YieldCAPM
Empirical Data and ResultsJournal ArticlesRegression Data
ConclusionsStrategyFuture Work
References
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Portfolio Strategy
I Should try to avoid highly volatile stocks – everybody islooking for the explosive investment
I Mentioned in BBBY PitchI Pitch more than stocks – look for an optimal portfolio, not
just a good stock
I Betting against beta should be persistentI Institutional biases
I Caveat:I Regression data is low R2, but Frazzini and Pedersen [2010]
has more portfolio based evidence
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Refinements
I More controlsI Becker and Ivashina [2013] – control for Fama-French, more
robust estimation
I Longer history of pricesI Can compare slopes with wider range of credit conditions
I Other asset classesI Could have implications for the corporate debt market
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Research Areas
I Relationship between business cycle and ’reaching for yield’I Becker and Ivashina [2013] – when growth is highI Frazzini and Pedersen [2010] – when growth (and thus interest
rates) are low
I Monetary Policy:I Potential new channel in which nominal shocks have real
effectsI Need better tools for macroprudential regulation if we want
extended periods of low interest rates – Stein [2011]
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Outline
IntroductionReaching for YieldCAPM
Empirical Data and ResultsJournal ArticlesRegression Data
ConclusionsStrategyFuture Work
References
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Bibliography
Bo Becker and Victoria Ivashina. Reaching for yield in the bondmarket. Working Paper 18909, National Bureau of EconomicResearch, March 2013. URLhttp://www.nber.org/papers/w18909.
Andrea Frazzini and Lasse H. Pedersen. Betting against beta.Working Paper 16601, National Bureau of Economic Research,December 2010. URL http://www.nber.org/papers/w16601.
Jeremy C. Stein. Monetary policy as financial-stability regulation.Working Paper 16883, National Bureau of Economic Research,March 2011. URL http://www.nber.org/papers/w16883.