Can No-Arbitrage SDF Models with Regime Shifts Explain the Correlations between Commodity, Stock, and Bond Returns?

37 Pages Posted: 6 May 2016 Last revised: 19 Dec 2016

See all articles by Marta Giampietro

Marta Giampietro

Bocconi University - Baffi Carefin Centre

Massimo Guidolin

Bocconi University - Department of Finance

Manuela Pedio

Bocconi University - CAREFIN - Centre for Applied Research in Finance

Date Written: December 1, 2015

Abstract

We investigate whether it is possible to find a Stochastic Discount Factor (SDF) that jointly prices the cross-section of eight U.S. portfolios of stocks, Treasuries, corporate bonds, and commodities and replicates their observed moments, and especially correlations. We use the first three principal components extracted from a set of 112 U.S. macro variables as pricing factors. We also introduce commodity-based factors in the SDF, motivated by commodity pricing theories and we use them either separately or in conjunction with the macro-based ones. We report that it is not impossible to find a set of macroeconomic factors able to jointly price the cross section of stocks, bonds, and commodities; however, this task is accomplished by a small set of commodity-based factors. Observed correlations for commodities are perfectly matched by a parsimonious, single state, diagonal factor VAR model where only three commodity-based factors enter the SDF. While introducing regimes does not improve the performance in all cases, they could be beneficial to replicating correlations among commodity and bond portfolios.

Suggested Citation

Giampietro, Marta and Guidolin, Massimo and Pedio, Manuela, Can No-Arbitrage SDF Models with Regime Shifts Explain the Correlations between Commodity, Stock, and Bond Returns? (December 1, 2015). BAFFI CAREFIN Centre Research Paper No. 2016-19, Available at SSRN: https://ssrn.com/abstract=2776076 or http://dx.doi.org/10.2139/ssrn.2776076

Marta Giampietro

Bocconi University - Baffi Carefin Centre ( email )

Via Roentgen 1
Milan
Italy

Massimo Guidolin (Contact Author)

Bocconi University - Department of Finance ( email )

Via Roentgen 1
Milano, MI 20136
Italy

Manuela Pedio

Bocconi University - CAREFIN - Centre for Applied Research in Finance ( email )

Via Sarfatti, 25
Milan, 20136
Italy

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