The performance of U.S. financial assets in expansions and recessions.

Author:Mukherji, Sandip

    Asset pricing models generally assume that investors are risk-averse, implying that expected returns on financial assets are directly related to their perceived risk. Researchers have provided evidence of mean reversion in stock returns. Poterba and Summers (1988) reported that real and excess returns on U.S. stocks had negative autocorrelations over 3- to 8-year periods. Fama and French (1988) documented large negative autocorrelations in U.S. stock returns for periods exceeding a year and showed that the explanatory power of mean reversion in 3-5 year returns was 25% for large stocks and 40% for small stocks. In an efficient market mean reversion in stock returns should reflect fluctuations in risk. Recurring cycles of business expansions and recessions offer a plausible explanation for time-varying risk and returns.

    There is evidence that business conditions impact returns on financial assets. Fama and French (1989) found that expected excess returns on stocks and bonds are negatively related to business conditions. Chordia and Shivakumar (2002) showed that momentum strategies generate significant positive returns only during expansions, and macroeconomic variables have predictive power for stock returns, suggesting that stock return momentum may be explained by time-varying expected returns. Yang, Zhou, and Wang (2009) reported that, compared to the U.S. government bond premium, the stock premium was higher in expansions and lower in recessions, and U.S. stock and bond premiums were both more volatile in recessions than in expansions.

    Studies have indicated that inflation has a significant impact on financial asset returns. Fama and Schwert (1977) found that T. Bills and intermediate government bonds provided complete hedges against expected inflation, but stock returns were negatively related to expected inflation. Boudoukh and Richardson (1993) showed that long-horizon stock returns were positively related to both ex ante and ex post long-term inflation. As Fama and French (2002) pointed out, the goal of investment is consumption, which is based on real returns.

    This study investigates the real returns and risk of major U.S. financial assets during 14 business cycles from November 1927 through May 2009. The results show that stocks offered the highest risk premium per unit of risk during expansions but suffered large negative returns in recessions. Government bonds provided the best risk-return tradeoffs during recessions and the worst tradeoffs in expansions. Compared to recessions, expansions experienced higher inflation and provided higher returns on stocks but lower returns on bonds and bills. Stocks offered the highest returns during expansions whereas bonds provided the highest returns during recessions. Since expansions lasted more than four times longer than recessions on average, stocks earned higher risk premiums and provided better risk-return tradeoffs than bonds across business cycles.


    Ibbotson Associates (2010) provides monthly inflation rates and real returns for 1926-2009 on six major U.S. financial assets: 30-day U.S. Treasury Bills (TB), intermediate-term government bonds (IGB), long-term government bonds (LGB), long-term corporate bonds (LCB), large company stocks (LCS), and small company stocks (SCS). The National Bureau of Economic Research (NBER) website ( reports the dates of U.S. business cycle expansions and recessions. NBER identifies 14 complete business cycles in the period for which data on asset returns are available. We studied these 14 cycles, starting with the first expansion beginning in November 1927 and ending with the last recession ending in May 2009. NBER defines a recession as "a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales." Turning points in business cycles began to be...

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