Jun 16, 2016 · 5:45 PM
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Nonlinearity and Flight-to-Safety in the Risk-Return Tradeoff for Stocks and Bonds
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. We further demonstrate that these findings are evidence of dynamic asset pricing theories where the time variation of the price of risk is a function of the level of the VIX.
Tobias Adrian is a Senior Vice President of the Federal Reserve Bank of New York and the Associate Director of Research and Statistics Group. His research covers asset pricing, financial intermediation, and macroeconomics, with a focus on the aggregate implications of capital market developments. He has contributed to the NY Fed's financial stability policy and to its monetary policy briefings. Tobias Adrian holds a Ph.D. from MIT and a MSc from LSE. He has taught at MIT, Princeton University, and NYU.
This a joint IAQF/Thalesians seminar, and not an instructional program of New York University.