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Nonlinearity and Flight‐to‐Safety in the Risk‐Return Trade‐Off for Stocks and Bonds
Author(s) -
ADRIAN TOBIAS,
CRUMP RICHARD K.,
VOGT ERIK
Publication year - 2019
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/jofi.12776
Subject(s) - bond , volatility (finance) , economics , equity (law) , econometrics , nonlinear system , stock (firearms) , financial economics , estimator , capital asset pricing model , monetary economics , mathematics , finance , geography , statistics , physics , archaeology , quantum mechanics , political science , law
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 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 in which the price of risk is a nonlinear function of market volatility.