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Bond Variance Risk Premia

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Author Info

  • Philippe Mueller

    ()

  • Andrea Vedolin

    ()

  • Yu-min Yen

    ()

Abstract

Using data from 1983 to 2010, we propose a new fear measure for Treasury markets, akin to the VIX for equities, labeled TIV. We show that TIV explains one third of the time variation in fund- ing liquidity and that the spread between the VIX and TIV captures flight to quality. We then construct Treasury bond variance risk premia as the difference between the implied variance and an expected variance estimate using autoregressive models. Bond variance risk premia display pronounced spikes during crisis periods. We show that variance risk premia encompass a broad spectrum of macroeconomic uncertainty. Uncertainty about the nominal and the real side of the economy increase variance risk premia but uncertainty about monetary policy has a strongly neg- ative effect. We document that bond variance risk premia predict excess returns on Treasuries, stocks, corporate bonds and mortgage-backed securities, both in-sample and out-of-sample. Fur- thermore, this predictability is not subsumed by other standard predictors.

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Bibliographic Info

Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp699.

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Date of creation: Jan 2012
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Handle: RePEc:fmg:fmgdps:dp699

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Web page: http://www.lse.ac.uk/fmg/

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References

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  1. Lieven Baele, 2010. "The Determinants of Stock and Bond Return Comovements," Review of Financial Studies, Society for Financial Studies, vol. 23(6), pages 2374-2428, June.
  2. Caio Almeida & Jeremy J. Graveline & Scott Joslin, 2005. "Do Options Contain Information About Excess Bond Returns?," IBMEC RJ Economics Discussion Papers 2005-04, Economics Research Group, IBMEC Business School - Rio de Janeiro.
  3. Thomas Busch & Bent Jesper Christensen & Morten Ørregaard Nielsen, 2007. "The Role of Implied Volatility in Forecasting Future Realized Volatility and Jumps in Foreign Exchange, Stock, and Bond Markets," CREATES Research Papers 2007-09, School of Economics and Management, University of Aarhus.
  4. Geert Bekaert & Marie Hoerova & Marco Lo Duca, 2012. "Risk, uncertainty and monetary policy," Working Paper Research 229, National Bank of Belgium.
  5. Clotilde Napp & Elyès Jouini, 2007. "Consensus consumer and intertemporal asset pricing with heterogeneous beliefs," Post-Print halshs-00152348, HAL.
  6. Philippe Mueller & Andrea Vedolin & Hao Zhou, 2011. "Short Run Bond Risk Premia," FMG Discussion Papers dp686, Financial Markets Group.
  7. Ruslan Bikbov & Mikhail Chernov, 2009. "Unspanned Stochastic Volatility in Affine Models: Evidence from Eurodollar Futures and Options," Management Science, INFORMS, vol. 55(8), pages 1292-1305, August.
  8. Bollerslev, Tim & Gibson, Michael & Zhou, Hao, 2011. "Dynamic estimation of volatility risk premia and investor risk aversion from option-implied and realized volatilities," Journal of Econometrics, Elsevier, vol. 160(1), pages 235-245, January.
  9. Clark, Todd E. & McCracken, Michael W., 2001. "Tests of equal forecast accuracy and encompassing for nested models," Journal of Econometrics, Elsevier, vol. 105(1), pages 85-110, November.
  10. Fulvio Corsi & Davide Pirino & Roberto Renò, 2010. "Threshold bipower variation and the impact of jumps on volatility forecasting," Post-Print peer-00741630, HAL.
  11. Jouini, Elyès & Napp, Clotilde, 2007. "Consensus Consumer and Intertemporal Asset Pricing with Heterogeneous Beliefs," Economics Papers from University Paris Dauphine 123456789/78, Paris Dauphine University.
  12. Joost Driessen & Pascal J. Maenhout & Grigory Vilkov, 2009. "The Price of Correlation Risk: Evidence from Equity Options," Journal of Finance, American Finance Association, vol. 64(3), pages 1377-1406, 06.
  13. Ian Martin, 2011. "Simple Variance Swaps," NBER Working Papers 16884, National Bureau of Economic Research, Inc.
  14. Casassus, Jaime & Collin-Dufresne, Pierre & Goldstein, Bob, 2005. "Unspanned stochastic volatility and fixed income derivatives pricing," Journal of Banking & Finance, Elsevier, vol. 29(11), pages 2723-2749, November.
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Cited by:
  1. Hongjun Yan & Jinfan Zhang & Dong Lou, 2011. "Anticipated and Repeated Shocks in Liquid Markets," FMG Discussion Papers dp684, Financial Markets Group.
  2. Aytek Malkhozov & Philippe Mueller & Andrea Vedolin & Gyuri Venter, 2013. "Mortgage Hedging in Fixed Income Markets," FMG Discussion Papers dp722, Financial Markets Group.
  3. Bo Young Chang & Bruno Feunou, 2013. "Measuring Uncertainty in Monetary Policy Using Implied Volatility and Realized Volatility," Working Papers 13-37, Bank of Canada.

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