Working Paper: CEPR ID: DP11401
Authors: Tobias Adrian; Richard K. Crump; Erik Vogt
Abstract: We document a highly significant, strongly nonlinear dependence of stock and bond returns on past equity market volatility as measured by the VIX. We propose a new estimator for the shape of the nonlinear forecasting relationship that exploits additional variation in the cross-section of returns. The nonlinearities are mirror images for stocks and bonds, revealing flight-to-safety: expected returns increase for stocks when volatility increases from moderate to high levels while they decline for Treasuries. These findings provide support for dynamic asset pricing theories where the price of risk is a nonlinear function of market volatility.
Keywords: flight-to-safety; risk-return tradeoff; dynamic asset pricing; volatility; nonparametric estimation and inference; intermediary asset pricing; asset management
JEL Codes: G12; G17; G01
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Past equity market volatility (G17) | Expected returns for stocks (G17) |
| Past equity market volatility (G17) | Expected returns for treasuries (G12) |
| Expected returns for stocks (G17) | Flight-to-safety effect (E44) |
| Expected returns for treasuries (G12) | Flight-to-safety effect (E44) |
| VIX (C58) | Stock and bond returns (G12) |