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The Effects of Interest Rate Movements on Assets’ Conditional Second Moments

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  • Alessandro Palandri

    () (University of Copenhagen and CREATES)

Abstract

This paper investigates whether the short term interest rate may explain the movements observed in the conditional second moments of asset returns. The theoretical connections between these seemingly unrelated quantities are studied within the C-CAPM framework. Under the assumption that the product of the relative risk aversion coefficient and the marginal utility is monotonic in consumption, original results are derived that attest the existence of a relation between the risk-free rate and the conditional second moments. The empirical findings, involving 165 stock returns quoted at the NYSE, confirm that, at low frequencies, the interest rate is a determinant of the 165 conditional variances and 13530 conditional correlations.

Suggested Citation

  • Alessandro Palandri, 2009. "The Effects of Interest Rate Movements on Assets’ Conditional Second Moments," CREATES Research Papers 2009-32, Department of Economics and Business Economics, Aarhus University.
  • Handle: RePEc:aah:create:2009-32
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    File URL: ftp://ftp.econ.au.dk/creates/rp/09/rp09_32.pdf
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    References listed on IDEAS

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    1. Robert F. Engle & Jose Gonzalo Rangel, 2008. "The Spline-GARCH Model for Low-Frequency Volatility and Its Global Macroeconomic Causes," Review of Financial Studies, Society for Financial Studies, vol. 21(3), pages 1187-1222, May.
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    3. King, Mervyn & Sentana, Enrique & Wadhwani, Sushil, 1994. "Volatility and Links between National Stock Markets," Econometrica, Econometric Society, vol. 62(4), pages 901-933, July.
    4. Palandri, Alessandro, 2009. "Sequential conditional correlations: Inference and evaluation," Journal of Econometrics, Elsevier, vol. 153(2), pages 122-132, December.
    5. Schwert, G William, 1989. " Why Does Stock Market Volatility Change over Time?," Journal of Finance, American Finance Association, vol. 44(5), pages 1115-1153, December.
    6. Bollerslev, Tim, 1986. "Generalized autoregressive conditional heteroskedasticity," Journal of Econometrics, Elsevier, pages 307-327.
    7. Balduzzi, Pierluigi & Elton, Edwin J. & Green, T. Clifton, 2001. "Economic News and Bond Prices: Evidence from the U.S. Treasury Market," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 36(04), pages 523-543, December.
    8. Michael J. Fleming & Eli M. Remolona, 1999. "Price Formation and Liquidity in the U.S. Treasury Market: The Response to Public Information," Journal of Finance, American Finance Association, vol. 54(5), pages 1901-1915, October.
    9. Hamilton, James D & Gang, Lin, 1996. "Stock Market Volatility and the Business Cycle," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 11(5), pages 573-593, Sept.-Oct.
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    Cited by:

    1. Markopoulou, Chryssa & Skintzi, Vasiliki & Refenes, Apostolos, 2016. "On the predictability of model-free implied correlation," International Journal of Forecasting, Elsevier, vol. 32(2), pages 527-547.

    More about this item

    Keywords

    Conditional Variance; Conditional Correlations; Interest Rate; Capital Asset Pricing Model; Sequential Conditional Correlations;

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G19 - Financial Economics - - General Financial Markets - - - Other
    • C50 - Mathematical and Quantitative Methods - - Econometric Modeling - - - General

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