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Modeling the joint dynamics of risk-neutral stock index and bond yield volatilities

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  • Zhou, Yinggang

Abstract

This study examines the joint evolution of risk-neutral stock index and bond yield volatilities by using the Chicago Board Option Exchange S&P500 volatility index (VIX) and the Bank of America Merrill Lynch Treasury Option Volatility Estimate Index (MOVE). I use bivariate regime-switching models to investigate the alternation of “high-risk” and “low-risk” markets, where the high-risk regime is characterized by higher and more volatilities with weaker cross-market linkages. Common information about economic and financial conditions appears to drive VIX and MOVE fluctuations between the two risk regimes. Two-regime specifications also distinguish between information spillover and common information effects. Ignoring regime shifts leads to spurious extreme persistence and incomplete inferences about asymmetric volatility. The findings carry important implications for asset allocation.

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  • Zhou, Yinggang, 2014. "Modeling the joint dynamics of risk-neutral stock index and bond yield volatilities," Journal of Banking & Finance, Elsevier, vol. 38(C), pages 216-228.
    • Handle: RePEc:eee:jbfina:v:38:y:2014:i:c:p:216-228
    DOI: 10.1016/j.jbankfin.2013.10.010
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    More about this item

    Keywords

    Option-implied volatility; VIX; MOVE; Common information; Information spillover; Regime switch;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models

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