Essays on macro-finance

Abstract

This thesis on topics in macro-finance, considers the relationship between the macro economy and also financial marets. We examine the key predictors, including macro determinants and technical indicators, of returns to the US stock market. Moreover, we investigate the links between financial markets internationally. We also study the importance of financial factors for monetary policy. In more detail, Chapter 2 constructs a flexible Bayesian framework to predict the equity premium, allowing for abrupt or gradual or even no changes in forecasting models and in coefficients. This approach has out-of-sample predictive power statistically and economically. Moreover, this model dominates its nested combination methods, including equal-weighted models, Bayesian and dynamic model averaging. By decomposing the prediction variance, we find that our approach precisely identifies the locally appropriate time variation in coefficients and the forecasting model over time, leading to mitigation of estimation risk. We then go on in Chapter 3 to model and predict financial integration, given the rapidly evolving nature of financial globalization. Importantly, this chapter allows national exposure to the global financial factors and the process driving volatility to vary over time. The obtained results show that financial integration is highly predictable, which has implications for international diversification, risk management and policy making. The CBOE volatility index (VIX) is identified as a strong predictor of financial integration, reflecting the vulnerability of financial markets to uncertainty. Our third main chapter, Chapter 4 studies how the impact of monetary policy shocks interact with the financial environment, in particular with financial uncertainty. The work identifies that monetary shocks have stronger, but less persistent, effects during periods of elevated financial uncertainty compared to more tranqil periods. These differences in effects among the uncertainty dependent states suggest that nonlinearities in the credit channel are stronger in the short run, whereas in the long run nonlinearities in the interest rate channel dominate.