Sandro C. Andrade

Market Timing with Cay

Market timing strategies using deviations from the long-run log consumption-wealth ratio (Cay) are tested to evaluate whether such strategies deliver superior investment performance. Several statistical tests indicate that true Cay embeds economically significant information about future market returns. At the same time, constraints such as the need to use the estimated rather than true ratio and delays in availability of macroeconomic data cast doubt on the likelihood that the market can be timed using mechanistic strategies based on Cay. Further research will ascertain whether it is possible to implement successful timing strategies using such a ratio.

Pessimistic Foreign Investors and Turmoil in Emerging Markets: The Case of Brazil in 2002

Using survey data, we document that foreign-owned institutions became more pessimistic than locally owned institutions about the strength of the Brazilian currency around the 2002 presidential elections. As a result of their relative pessimism, foreignowned institutions made larger forecast errors. Consistent with the emergence of their relative pessimism, foreign investors heavily sold Brazilian stocks and the Brazilian currency in futures markets ahead of the 2002 elections. Periods of stronger foreign sell-off were associated with larger equity price declines and larger depreciation of the Brazilian Real in spot and futures markets. These results are consistent with foreign investors’ lack of knowledge of Brazilian institutions contributing to the sharp depreciation of the Brazilian currency and stock market ahead of the 2002 presidential elections.

A Practical Anti-Bubble Prescription

We argue that coordinated mass dissemination of information about asset fundamentals should make asset markets less prone to bubbles. The key idea is to establish a centralized and popular information source to make key information common knowledge across as many market participants as possible. This realistic, micro-level anti-bubble policy faces fewer challenges than monetary policy and macro-prudential tools.

The Costs of Sovereign Default: Evidence from the Stock Market

We use stock market data to test cross-sectional implications of theories of sovereign default and provide a market-based estimate of sovereign default costs. We find that the stock prices of firms vulnerable to financial intermediation disruption, or firms more exposed to the government, are particularly sensitive to changes in sovereign credit spreads. This is consistent with theories in which default is costly because it disrupts financial intermediation and damages government reputation. Estimation of a structural valuation model indicates that the market prices stocks as if sovereign default has large effects on vulnerable stocks, translating to a 12% destruction of the value of their productive assets. Received July 9, 2011; editorial decision August 16, 2017 by Editor Geert Bekaert.

Is There a Value Premium Among Large Stocks

According to Fama and Frenchs (2012) price-to-book sorts, there is no global value premium among large stocks. Two simple departures from their methodology restore such premium: sorting stocks based on price-to-earnings rather than price-to-book ratios, and using global rather than regional value breakpoints. The resulting global value premium among large stocks, measured as the return spread between top 30% and bottom 30% stocks, increases from 17 (t-stat=1.09) to 64 (t-stat=2.61) basis points per month. Using price-to-earnings computed from earnings estimates rather than historical earnings further sharpens the value effect among large stocks. Not confined to small stocks, the value premium remains a key topic in Finance. Because valuation ratios are not interchangeable, researchers should look beyond price-to-book when studying, or controlling for, the value effect.

Macroeconomic Risk, Investor Preferences, and Sovereign Credit Spreads

We study how shifting global macroeconomic conditions affect sovereign bond prices. Bondholders earn premia for two sources of systematic risk: exposure to low-frequency changes in the state of the economy, as captured by expected macroeconomic growth and volatility, and exposure to higher-frequency macroeconomic shocks. Our model predicts that the first source, labeled “long-run macro risk”, is the primary driver of the level and the cross-sectional variation in sovereign bond premia. We find support for this prediction using sovereign bond return data for 43 countries. A long-short portfolio based on long-run macro risk earns 8.11% per year in our sample.