Essays in Financial Economics

Chapter 1: What Flows Around Comes Around: Mean Reversion and Portfolio Flows This paper investigates mean reversion properties of real effective exchange rates (REERs) using a semi-parametric quantile autoregression approach. This method accounts for nonnormality and captures asymmetric and dynamic adjustments towards the REER’s long run equilibrium, conditional on the size of the shock to the REER. Due to the nonstandard limiting distribution of our tests, we apply a resampling procedure for robust inference. Using a sample of 29 countries over the period 1980–2017, we indeed show that the REER features non-linear mean-reverting tendencies following large shocks. The REER adjusts dynamically and asymmetrically towards its long run equilibrium, conditional on the size of the shock. We find half-lives of less than one year in some cases for the most extreme quantiles. Additionally, panel regressions indicate that this behavior can be explained by portfolio flows. Large deviations in the REER from its long run mean are followed by debt portfolio flows from international investors. These flows are associated with an appreciation in the REER, conditional on the level of deviation and the shocks incurred, leading to faster mean reversion in REERs. In the most extreme quantile, the flows move the REER back towards its mean by 1.78% per month. Chapter 2: Understanding Volatility-Managed Portfolios Contrary to the intuition that the standard risk-return tradeoff should lead to underperformance of a portfolio that scales down exposure during volatile periods a recent paper by Moreira and Muir (2017) actually shows that volatility-managed portfolios produce robust and significant alphas. The present paper investigates the mechanisms that lead to the outperformance of volatility management. By implementing timing regressions and relating returns of a volatility-managed portfolio to discount-rate, cash-flow and expected volatility news we provide evidence that volatility management outperforms by levering up good times without increasing downside exposure to fundamental risk drivers. On the contrary, during the most severe cumulative news shocks (either to cash flows, discount rates or expected volatility) the scaling strategy suffers less than the buy-and-hold portfolio and, thus, increases investor utility. Furthermore, we relate volatility-managed strategies to popular timing strategies based on a measure of risk-neutral variance as a lower bound for the expected equity risk premium. We find that strategies that combine elements from both, volatility management and timing based on risk-neutral variance, outperform over a recent sample period and produce significant alphas in spanning regressions, posing further puzzles for the asset pricing literature. Chapter 3: Analyst Forecasts and Currency Markets I examine the forecasting performance, directional accuracy, rationality and economic value of analyst forecasts and characteristics of investment portfolios built from these forecasts for 30 currency pairs from 2006 to 2020. My results show that analyst forecasts perform worse than forecasts based on a random walk and forward rates and that they are biased and do not provide significant economic value to investors. Forecasts from global systemically important banks do not differ from non-systemically important banks in terms of forecasting ability. Median forecasts may strongly deviate from market expectations, while analyst forecast dispersion is positively associated with future currency returns. Portfolios built from analyst forecasts tend to strongly underperform the dollar factor, value, carry and momentum portfolios and are spanned by them. My findings indicate that expected returns extracted from analyst forecasts are negatively related to realized excess returns in FX markets and thus contribute to the literature on survey-based returns in asset pricing.