| In the first chapter, co-authored with Dr. Jessica A. Wachter, we solve the portfolio problem of a long-run investor when the term structure is Gaussian and when the investor has access to nominal bonds and stock. We apply our method to a three-factor model that captures the failure of the expectations hypothesis. We extend this model to account for time-varying expected inflation, and estimate the model with both inflation and term structure data. The estimates imply that the bond portfolio of a long-run investor looks very different from the portfolio of a mean-variance optimizer. In particular, time-varying term premia generate large hedging demands for long-term bonds.; The second chapter, studies the behavior of corporate bond indices. We find that a 2-factor model with unobservable factors is adequate in capturing the variation of corporate bond portfolio returns, however we cannot identify any linear regression model with observable variables that would be able to do so. Including several economic variables as regressors, like the Fama-French factors, liquidity factors, and allowing for time-varying coefficients did not save the model. Principal component analysis revealed that the residuals from our regressions are highly correlated, with the first factor explaining around 86 percent of the remaining variation. Furthermore, there is a big difference in the R2's, and the coefficients of the factors between the high and low-grade bonds. We view our findings as evidence in favor of segmentation between the Treasury, equity, and corporate bond markets, as well as evidence of segmentation within the corporate bond market.; In addition, not only are corporate bond excess returns predictable, but the big missing factor is also predictable. This is particularly important for investing and hedging with corporate bonds.; The third chapter, studies how the consumption and portfolio choice changes when the investor has access to corporate bond portfolios, in addition to an aggregate equity index and Treasury securities. More importantly this chapter documents the big utility benefits the investor derives by including corporate bonds in her portfolio. I solve the problem for an investor with Duffie-Epstein utility, in an affine economy where the risk premia of all assets are time varying and functions of four business cycle variables. The first contribution of this paper is to analyze the effect of each business cycle variable on the portfolio demands for each asset separately and collectively and to explain the shape and magnitude of hedging demands. The second contribution of this paper is to document the big additional benefits corporate bonds offer to the investor. Corporate bonds greatly improve the investor's welfare. Hedging demands associated with corporate bonds play a much more important role for an investor than the increased ability to diversify and time the market when she includes corporate bonds in her portfolio. In particular 80% of the utility benefits that arise from investing in corporate bonds comes from the hedging demand for corporate bonds. In addition, comparing the effect of low grade bonds vs high grade bonds, we find that low grade bonds improve the welfare of the investor to a much greater degree. Given the big utility gains and the level of the optimal allocations to corporate bonds, it is a puzzle that corporate bonds are so under-represented in the portfolios of households, as documented in other studies. |
