Up Next

ki-logo-white
Market-Based Solutions to Vital Economic Issues

SEARCH

ki-logo-white
Market-Based Solutions to Vital Economic Issues
Research
Oct 26, 2009

Regime-Switching in Stock Index and Treasury Futures Returns and Measures of Stock Market Stress

Abstract

We investigate bivariate regime‐switching in daily futures‐contract returns for the US stock index and ten‐year Treasury notes over the crisis‐rich 1997–2005 period. We allow the return means, volatilities, and correlation to all vary across regimes. We document a striking contrast between regimes, with a high‐stress regime that exhibits a much higher stock volatility, a much lower stock–bond correlation, and a higher mean bond return. The high‐stress regime is associated with higher average values of stock‐implied volatility, stock illiquidity, and stock and bond futures trading volume. The lagged implied volatility from equity‐index options is useful in modeling the time‐varying transition probabilities of the regime‐switching process. Our findings support the notions that: (1) stock market stress can have a material influence on Treasury bond pricing, and (2) the diversification benefits of combined stock–bond holdings tend to be greater during times with relatively high stock market stress.


View Working Paper View Publication on UNC Library View Publication on Journal Site

You may also be interested in: