This was a presentation that I prepared for my investment club, MII, on the phenomenon of 'reaching for yield'

1. Reaching for Yield
Yichuan Wang
Michigan Interactive Investments
University of Michigan
April 7, 2013

2. Outline
Introduction
Reaching for Yield
CAPM
Empirical Data and Results
Journal Articles
Regression Data
Conclusions
Strategy
Future Work
References

3. Outline
Introduction
Reaching for Yield
CAPM
Empirical Data and Results
Journal Articles
Regression Data
Conclusions
Strategy
Future Work
References

4. Reaching for Yield
When rates of return are low, people go into riskier assets
Imagine you are a pension manager
You need to get 3% yield, but Interest rates are very low
Figure: Bond Yields

5. Choice of Assets
One potential solution: risker stocks – better to go for broke
than to get fired
0.4
0.3
0.2
0.1
0.0
−5 0
Return
Figure: Return Distributions

6. Tangent – CAPM
Basic idea: risk compensated by return
Risk: Market Beta
Return: Alpha
Standard CAPM:
ri ∼ αi + βi rm
Beta (βi ) – measure of volatility, used to indicate risk, but not
perfect
Example: Deep out of the money puts
But is sufficient for a short term measure of ’reaching for yield’

7. Example With McDonalds
0.050
0.025
Year
2013
2012
2011
MCD
0.000
2010
2009
2008
2007
−0.025
−0.050
−0.050 −0.025 0.000 0.025 0.050
SPY
Figure: MCD vs. SPY Daily Returns

8. Example with McDonalds
0.0050
0.0025
Year
2013
2012
2011
MCD
0.0000
2010
2009
2008
2007
−0.0025
−0.0050
−0.0050 −0.0025 0.0000 0.0025 0.0050
SPY
Figure: Return Scatterplot – Alpha is the Y-Intercept

9. Outline
Introduction
Reaching for Yield
CAPM
Empirical Data and Results
Journal Articles
Regression Data
Conclusions
Strategy
Future Work
References

10. Insurance Portfolios
Prevalent in corporate bond market - Abstract from Becker
and Ivashina [2013]
...insurance portfolios are systematically biased toward
higher yield, higher CDS bonds. Reaching-for-yield ... is
also more pronounced for firms with poor corporate
governance and for which regulatory capital requirement
is more binding. A comparison of the ex-post performance
of bonds acquired by insurance companies shows no
outperformance, but higher systematic risk and volatility.
Matches theory:
1. Poor corporate governance and binding capital makes ’going
for broke’ more attractive
2. Negative sum game – higher risk and volatility

11. Stock Prices and Portfolio Strategy
Suggests high beta stocks will earn lower risk-adjusted returns
when credit is easy
Risk-adjusted is important – helps filter out the noise from
market returns
Easy credit allows firms to lever up to pursue these high risk
strategies
Betting against beta factor Frazzini and Pedersen [2010]
We test the model’s predictions within U.S. equities,
across 20 global equity markets, for Treasury bonds,
corporate bonds, and futures. Consistent with the model,
we find in each asset class that a betting-against-beta
(BAB) factor which is long a leveraged portfolio of
low-beta assets and short a portfolio of high-beta assets
produces significant risk-adjusted returns. When funding
constraints tighten, betas are compressed towards one,
and the return of the BAB factor is low.

12. Portfolio Performance
Figure: Monthly Alpha (Percent) for Portfolios Sorted into Beta Deciles

13. Dependence on Funding Conditions
Figure: Frazzini and Pedersen [2010] BAB Regressions

14. Stock Price Regressions
We can see effects of ’Betting against Beta’ in a simple
regression!
Take price history of almost all stocks traded on US exchanges
from available price data from 2007 – Present
Comprise ∼100% of total market capitalization
Weight regressions by market capitalization, use robust
regression (Huber M-Estimator)
Specification:
1. Standard CAPM:
ri ∼ αi + βi rm
2. Betting Against Beta (b):
αi ∼ a + b |βi |

15. Data Source
’Yahoo Finance’, interfaced through open source R:
Quantmod, TTR, ggplot2
Figure: Console Output of Code

16. Yearly Results
Reaching for Yield?
0.05
0.00
−0.05
Beta Coefficient
−0.10
−0.15
−0.20
2007 2008 2009 2010 2011 2012
Figure: Coefficient (b) for 2007 – 2012

17. Sorted by Market Capitalization
Reaching for Yield?
0.2
0.1 BetaSE
0.030
0.025
0.0 0.020
Beta Coefficient
0.015
0.010
−0.1
Market Cap
Small
Medium
−0.2
Large
−0.3
2007 2008 2009 2010 2011 2012
Figure: Divided by Market Capitalization

18. Outline
Introduction
Reaching for Yield
CAPM
Empirical Data and Results
Journal Articles
Regression Data
Conclusions
Strategy
Future Work
References

19. Portfolio Strategy
Should try to avoid highly volatile stocks – everybody is
looking for the explosive investment
Mentioned in BBBY Pitch
Pitch more than stocks – look for an optimal portfolio, not
just a good stock
Betting against beta should be persistent
Institutional biases
Caveat:
Regression data is low R 2 , but Frazzini and Pedersen [2010]
has more portfolio based evidence

20. Refinements
More controls
Becker and Ivashina [2013] – control for Fama-French, more
robust estimation
Longer history of prices
Can compare slopes with wider range of credit conditions
Other asset classes
Could have implications for the corporate debt market

21. Research Areas
Relationship between business cycle and ’reaching for yield’
Becker and Ivashina [2013] – when growth is high
Frazzini and Pedersen [2010] – when growth (and thus interest
rates) are low
Monetary Policy:
Potential new channel in which nominal shocks have real
effects
Need better tools for macroprudential regulation if we want
extended periods of low interest rates – Stein [2011]

22. Outline
Introduction
Reaching for Yield
CAPM
Empirical Data and Results
Journal Articles
Regression Data
Conclusions
Strategy
Future Work
References

23. Bibliography
Bo Becker and Victoria Ivashina. Reaching for yield in the bond
market. Working Paper 18909, National Bureau of Economic
Research, March 2013. URL
http://www.nber.org/papers/w18909.
Andrea Frazzini and Lasse H. Pedersen. Betting against beta.
Working Paper 16601, National Bureau of Economic Research,
December 2010. URL http://www.nber.org/papers/w16601.
Jeremy C. Stein. Monetary policy as financial-stability regulation.
Working Paper 16883, National Bureau of Economic Research,
March 2011. URL http://www.nber.org/papers/w16883.