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What Ties Return Volatilities to Price Valuations and Fundamentals?

  • Alexander David
  • Pietro Veronesi
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    Stock and Treasury bond comovement, volatilities, and their relations to their price valuations and fundamentals change stochastically over time, both in magnitude and direction. These stochastic changes are explained by a general equilibrium model in which agents learn about composite economic and inflation regimes. We estimate our model using both fundamentals and asset prices, and find that inflation news signal either positive or negative future real economic growth depending on the times, thereby affecting the direction of stock/bond comovement. The learning dynamics generate strong non-linearities between volatilities and price valuations. We find empirical support for numerous predictions of the model.

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    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 15563.

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    Date of creation: Dec 2009
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    Publication status: published as Journal of Political Economy, Summer 2013, 121, 4, 682 - 746
    Handle: RePEc:nbr:nberwo:15563
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