NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH
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The Leverage Factor: Credit Cycles and Asset Returns

Josh Davis, Alan M. Taylor

NBER Working Paper No. 26435
Issued in November 2019, Revised in November 2019
NBER Program(s):Asset Pricing Program, Program on the Development of the American Economy, Economic Fluctuations and Growth Program, International Finance and Macroeconomics Program, Monetary Economics Program

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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Document Object Identifier (DOI): 10.3386/w26435

 
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