Discussion Paper Details

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Title: The Leverage Factor: Credit Cycles and Asset Returns

Author(s): Josh Davis and Alan M. Taylor

Publication Date: November 2019

Keyword(s): asset allocation, Asset Pricing, Cycles, debt, leverage and return predictability

Programme Area(s): Economic History, Financial Economics, Macroeconomics and Growth and Monetary Economics and Fluctuations

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.

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Bibliographic Reference

Davis, J and Taylor, A. 2019. 'The Leverage Factor: Credit Cycles and Asset Returns'. London, Centre for Economic Policy Research.