The Leverage Factor: Credit Cycles and Asset Returns

Research has found strong links between past credit booms and adverse outcomes for macroeconomic aggregates like output investment. However, are price impacts also seen more widely in broad asset classes such as equity fixed-income markets? We document a robust significant connection using large sample of historical data many advanced countries since 1870. Credit boom periods with high “leverage factor” tend to be predictably followed by unusually low returns risky equities, absolute terms relative safe portfolio. Fixed income is haven at these times slightly higher than normal returns. show properties hold in-sample out-of-sample. Return predictability because the leverage factor distinct from that momentum (lagged return) value (cashflow price). Trading strategies built on accrue meaningful excess profits This paper was accepted Victoria Ivashina, finance.