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Equity Return and Short-Term Interest Rate Volatility : Level Effects and Asymmetric Dynamics

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  • Olan T. Henry
  • Nilss Olekalns
  • Sandy Suardi

Abstract

Evidence suggests that short-term interest rate volatility peaks with the level of short rates, while equity volatility responds asymmetrically to positive and negative shocks. We present an LM based test that distinguishes between level effects and asymmetry in volatility which is robust to the presence of unidentified nuisance parameters under the null. There is strong evidence of a level effect and asymmetric response in the relationship between S&P 500 Index returns and 3-month US Treasury Bills. The conditional covariance depends on the level of the short rate which has implications for hedging equity returns against short term interest rate movements.

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Bibliographic Info

Paper provided by The University of Melbourne in its series Department of Economics - Working Papers Series with number 941.

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Length: 46 pages
Date of creation: 2005
Date of revision:
Handle: RePEc:mlb:wpaper:941

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Keywords: Level Effects; Asymmetry; LM Tests; Davies Problem; Nonlinear Granger Causality;

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References

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Cited by:
  1. Sandy Suardi & O.T.Henry & N. Olekalns, . "Testing for Rate-Dependence and Asymmetry in Inflation Uncertainty: Evidence from the G7 Economies," MRG Discussion Paper Series 0306, School of Economics, University of Queensland, Australia.
  2. Olan T. Henry & Sandy Suardi, 2004. "Testing for a Level Effect in Short-Term Interest Rates," Department of Economics - Working Papers Series 924, The University of Melbourne.

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