Pierluigi Balduzzi

Economic News and Bond Prices: Evidence from the U.S. Treasury Market

This Paper uses intraday data from the interdealer government bond market to investigate the effects of scheduled macroeconomic announcements on prices, trading volume, and bid-ask spreads. We find that 17 public news releases, as measured by the surprise in the announcced quantity, have a significant impact on the price of the following instruments: a three-month bill, a two-year note, a 10-year, anda 30-year bond. These effects vary significantly according to maturity. Public news can explain a substantial fraction of price volantility in the after math of announcements, and the adjustment to news generally occurs within one minute after the announcement. We document significant and persistent increases in volatility and trading volume after the announcements. Bidask spreads, on the other hand, widen at the timeof the announcements, but then revert to normal values after five to 15 minutes. The implications for yield curve modeling and for the microstructure of bond markets.

Portfolio Choice and Trading in a Large 401(k) Plan

We study nearly 7,000 retirement accounts during the April 1994-August 1998 period. Several interesting patterns emerge. Most asset allocations are extreme (either 100 percent or zero percent in equities) and there is inertia in asset allocations. Equity allocations are higher for males, married investors, and for investors with higher earnings and more seniority on the job; equity allocations are lower for older investors. There is very limited portfolio reshuffling, in sharp contrast to discount brokerage accounts. Daily changes in equity allocations correlate only weakly with same-day equity returns and do not correlate with future equity returns.

Predictability and Transaction Costs: The Impact on Rebalancing Rules and Behavior

We consider the impact of transaction costs on the portfolio decisions of a long-lived agent with isoelastic preferences. In particular, we focus on how portfolio choice, rebalancing frequency and average cost incurred change over the lifecycle are affected by return predictability. Two types of costs are evaluated: proportional to the change in the holding of the risky asset and a fixed fraction of portfolio value. We find that realistic transaction costs can materially affect rebalancing behavior, creating no-trade regions that widen near the investors terminal date. At the same time, realistic proportional and fixed costs have little effect on the midpoint of the no-trade region, unless liquidation costs differ across assets. Return predictability calibrated to U.S. stock returns is found to have large effects on rebalancing behavior relative to independent and identically distributed (i.i.d.) returns with the same unconditional distribution. For example, return predictability causes rebalancing frequency to increase, and cost incurred to increase by an order of magnitude, at all points in the investors life. No-trade regions early in life are wider when returns are predictable than when they are not. Finally, we find that the nature of the return predictability, including the presence or not of return heteroscedasticity, can have large effects on rebalancing behavior.

Interest Rate Targeting and the Dynamics of Short-Term Rates

We find that in 1989-1996, when U.S. monetary policy tightly targeted overnight fed funds rates, the volatility and persistence of spreads between target and term fed funds levels were larger for longer-maturity loans. We show that such patterns are consistent with an expectational model where target revisions are infrequent and predictable. In our model, the (autoco-) variance of the spreads of term fed funds rates from the target increases with maturity because longer-term rates are more heavily influenced by persistent expectations of future target changes.

Economic News and the Yield Curve: Evidence from the U.S. Treasury Market

This paper examines newly-available intra-day data from the inter-dealer government bond market to investigate the effects of economic-news announcements on prices, trading volume, and bid-ask spreads. The use of intra-day price data together with data on market expectations allows us to obtain new and different results relative to previous studies. We find a total of seventeen economic announcements to have a significant impact on the price of at least on

Mimicking Portfolios, Economic Risk Premia, and Tests of Multi-Beta Models

We consider two formulations of the linear factor model (LFM) with nontraded factors. In the first formulation, LFM, risk premia and alphas are estimated by a cross-sectional regression of average returns on betas. In the second formulation, LFM**, the factors are replaced by their projections on the span of excess returns, and risk premia and alphas are estimated by time series regressions. We compare the two formulations and study the small-sample properties of estimates and test statistics. We conclude that the LFM** formulation should be considered in addition to, or even instead of, the more traditional LFM formulation. For corrected versions of Tables 2, 6, and 7, please see the supplemental files posted with this article.

Asset-pricing Models and Economic Risk Premia: A Decomposition

The risk premia of linear factor models on economic (non-traded) risk factors can be decomposed into: i) the premium on maximum-correlation portfolios mimicking the factors; ii) (minus) the covariance between the non-traded components of the pricing kernel and the factors; and iii) (minus) the mispricing of the maximum-correlation portfolios. For a given set of assets available for investment, the first component is the same across models and is typically estimated with little bias and high precision. We conclude that the premia on maximum-correlation portfolios are appealing alternatives to the risk premia of linear factor models, with the dividend yield being the only economic factor significantly priced.

Financial Markets, Banks' Cost of Funding, and Firms' Decisions: Lessons from Two Crises

We test whether adverse changes to banks’ market valuations during the financial and sovereign debt crises, and the associated increase in banks’ cost of funding, affected firms’ real decisions. Using new data linking over 3,000 non-financial Italian firms to their bank(s), we find that increases in banks’ CDS spreads, and decreases in their equity valuations, resulted in lower investment, employment, and bank debt for younger and smaller firms. Importantly, these effects dominate those of banks’ balance-sheet variables. We also show that higher CDS spreads led to lower aggregate investment, employment, and a less efficient resource allocation.

Heterogeneity in Target-Date Funds: Optimal Risk-Taking or Risk Matching?

In this paper, we study the evolution of the market for target-date funds (TDFs) between 1994 and 2009. We document pronounced heterogeneity in the TDF universe: TDFs with the same target retirement date have delivered very different returns within the same year. We show that some of the heterogeneity in realized returns can be attributed to heterogeneity in allocations to stocks versus bonds. However, we also show that heterogeneity in idiosyncratic returns has increased over time, especially following the passage of the Pension Protection Plan of 2006, which encouraged the use of TDFs as default investments in defined contribution retirement plans. Indeed, we can attribute some of the increased heterogeneity in idiosyncratic returns to the entry of new fund families into the TDF market in 2007-2009. Because these families have few assets to lose if they underperform, and because we show that flows into TDFs chase idiosyncratic returns rather than total returns, we argue that the increased heterogeneity in idiosyncratic returns is consistent with entrants in the market internalizing their risk-taking incentives. From a policy perspective, our findings suggest that the widespread adoption of TDFs will not result in returns that are similar across investors enrolled in different 401(k) plans.Following the Pension Protection Act of 2006, there was a sharp increase in the use of TDFs as default investment options in defined contribution retirement plans. We document large differences in realized TDF returns and risk profiles, even for funds with the same target retirement date. Using fund-level data, we find evidence that this heterogeneity reflects optimal risk-taking by fund families with low market share, especially those entering the market after 2006. Using plan-level data, we find little evidence that 401(k) plan sponsors match the risk profile of the TDFs in their plans to the risks of their companies.

Minimum-Variance Kernels, Economic Risk Premia, and Tests of Multi-Beta Models

This paper uses minimum-variance (MV) admissible kernels to estimate risk premia associated with economic risk variables and to test multi-beta models. Estimating risk premia using MV kernels is appealing because it avoids the need to 1) identify all relevant sources of risk and 2) assume a linear factor model for asset returns. Testing multi-beta models in terms of restricted MV kernels has the advantage that 1) the candidate kernel has the smallest volatility and 2) test statistics are easy to interpret in terms of Sharpe ratios. The authors find that several economic variables command significant risk premia and that the signs of the premia mostly correspond to the effect that these variables have on the risk-return trade-off, consistent with the implications of the intertemporal capital asset pricing model (I-CAPM). They also find that the MV kernel implied by the I-CAPM, while formally rejected by the data, consistently outperforms a pricing kernel based on the size and book-to-market factors of Fama and French (1993).