The Leverage Factor: Credit Cycles and Asset Returns

24 Pages Posted: 4 Dec 2019

See all articles by Josh Davis

Josh Davis

Pacific Investment Management Company (PIMCO)

Alan M. Taylor

University of California, Davis - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: November 2019

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: asset allocation, Asset Pricing, Cycles, debt, leverage, return predictability

JEL Classification: E17, E20, E21, E32, E44, G01, G11, G12, G17, G21,

Suggested Citation

Davis, Josh and Taylor, Alan M., The Leverage Factor: Credit Cycles and Asset Returns (November 2019). CEPR Discussion Paper No. DP14115, Available at SSRN: https://ssrn.com/abstract=3496604

Josh Davis (Contact Author)

Pacific Investment Management Company (PIMCO) ( email )

United States

Alan M. Taylor

University of California, Davis - Department of Economics ( email )

One Shields Drive
Davis, CA 95616-8578
United States
530-752-1572 (Phone)
530-752-9382 (Fax)

HOME PAGE: http://www.econ.ucdavis.edu/faculty/amtaylor/

National Bureau of Economic Research (NBER)

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Centre for Economic Policy Research (CEPR)

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United Kingdom

HOME PAGE: http://cepr.org

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