We construct exogenous demand shocks using quarterly mutual fund flow data to estimate CUSIP and portfolio elasticities for U.S. corporate bonds. Our approach relaxes the homogeneous cross-elasticity assumption implicitly embedded in many existing methods. At the CUSIP level, the elasticity is around 25, suggesting bonds are considerably more elastic than stocks. While individual bonds are highly elastic, aggregated portfolios of bonds are not—rating-level portfolio's have elasticities as low as 0.2. Generally, demand elasticity is negatively related to the level of aggregation. We also find that demand is more elastic in the long run, with the price impact taking around three to four quarters to fully revert. Turning to heterogeneity in elasticities, we find high-yield and long-term bonds are more inelastic than investment-grade and short-term bonds. Furthermore, the sharp change in inelasticity around the IG/HY cut-off suggests that investor segmentation may be a source of demand inelasticity. Finally, we find difficult-to-replicate portfolios have more inelastic demand, consistent with greater arbitrage risk being a source of inelasticity. Overall, our findings contribute to understanding the key drivers of inelastic markets.
Presentations: NBER SI Asset Pricing 2023, AFA 2024, AFFECT 2023, Columbia Business School, University of Chicago, UCLA's David Backus Memorial Conference, and LBS's TADC, Yiran Fan Memorial Conference (poster)
Prizes: TADC’s AQR Asset Management Institute Prize for best economics paper
Do stocks protect against rising inflation expectations? We directly measure investors' expectations using traded inflation-indexed contracts and show that, post-2000, stocks offer positive returns in response to higher expected inflation: unconditionally, a 10 basis point increase in 10-year breakeven inflation is associated with a 1.1% increase in the value-weighted stock index. Using high-frequency identification around scheduled CPI releases, we show this relationship is likely causal. We provide evidence that the price increase is driven by lowering future expected excess returns rather than changing risk-free rates or cashflows: (1) in the cross-section, return responses are almost completely explained by CAPM beta but not by cashflow or leverage related variables, (2) VAR decompositions of returns as well as mediation regressions that directly control for alternate channels attribute nearly all the changes to expected excess returns. Finally, we show inflation expectations predict future output, suggesting that investors may use information about high future inflation as a signal for economic growth, thereby lowering risk premia.
Presentations: LBS's TADC, University of Chicago, Yiran Fan Memorial Conference (poster), CCSRG, Inter-finance PhD Seminar
Prizes: TADC’s AQR Asset Management Institute prize for best finance paper, Yiran Fan Memorial prize for best third year paper