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A new government bond volatility index predictor for the U.S. equity premium

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  • Pan, Zheyao
  • Chan, Kam Fong

Abstract

This study proposes a new predictor constructed under the state-preference asset pricing framework to forecast the U.S. monthly equity premium. The index, termed as the government bond volatility index or GBVX, reflects the Treasury implied volatility. The innovation in the GBVX delivers statistically and economically significant in-sample and out-of-sample predictive results over the recent 2000–2015 sample period. It yields a sizable increase in terminal wealth growth, Sharpe ratio, and utility gains. In addition, the predictive ability of the innovation in the GBVX is comparable to, and in a majority of cases, surpasses those of conventional predictors commonly used in the literature, as well as a range of historical and other implied volatility indices. The strong predictive ability of the innovation in the GBVX stems from its anticipation of cash flow news.

Suggested Citation

  • Pan, Zheyao & Chan, Kam Fong, 2018. "A new government bond volatility index predictor for the U.S. equity premium," Pacific-Basin Finance Journal, Elsevier, vol. 50(C), pages 200-215.
    • Handle: RePEc:eee:pacfin:v:50:y:2018:i:c:p:200-215
    DOI: 10.1016/j.pacfin.2016.12.007
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    3. Indriawan, Ivan & Jiao, Feng & Tse, Yiuman, 2021. "The FOMC announcement returns on long-term US and German bond futures," Journal of Banking & Finance, Elsevier, vol. 123(C).

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    More about this item

    Keywords

    Bond volatility index; Stock return predictability; Asset allocation; Out-of-sample test; Return decomposition;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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