Swedroe: Stock Volatility Moves Treasurys

October 21, 2015

  • Relatively high realized stock volatility in the previous month is reliably associated with higher subsequent stock volatility over the next month. For example, in the high-volatility state, the subsequent stock volatility was 33.3 percent versus 18.3 percent in the full sample, and 96.4 percent of these conditional stock volatilities were above the full-sample median. Alternatively, following months of low volatility, the conditional subsequent stock volatility was 9.9 percent, with only 5.1 percent of these conditional stock volatilities coming in above the full-sample median. In addition, the VIX is strikingly higher and more variable for observations that follow high realized stock volatility.
  • The conditional volatility of Treasury returns is also strikingly different, depending on whether the prior month’s stock volatility was extremely high or low. Treasury return volatilities that follow high stock volatility have a mean that’s about twice the comparable values for the observations that follow low stock volatility.
  • Lagged equity volatility is a substantial, reliable determinant of subsequent Treasury bond and Treasury note futures return volatility, and also of the subsequent volatility of the level and slope of the term structure.
  • Equity risk helps us to understand movements in the term structure, beyond an approach that looks only at the bond market in isolation.
  • Stock/bond return correlations are appreciably more negative for observations that follow high realized stock volatility.
  • FTQ/FFQ dynamics are a key contributor to the relationship between stock and bond market volatility. For example, a much stronger relationship exists during stressful, uncertain economic times (such as around recessions) when bond prices are likely to appreciate with heightened economic uncertainty because of a precautionary savings effect. In periods of low economic stress (the authors looked at two such periods: January 1993 to November 1996; and April 2004 to June 2007), the results indicate the lagged Treasury bond return volatility is the more important explanatory term.
  • The relationship remains strong when controlling for the lagged volatility of economic variables such as inflation and the default yield spread, variables that seem likely to be more linked to bond volatility but might also be embedded in equity volatility.


The authors’ finding that a stronger relationship occurs during periods of higher stress/volatility in the stock market is evidence that should be expected through the flight-to-quality avenue. Thus, there is an episodic nature of the time-varying relationship between stock and bond market volatility.

They also found that Treasury bonds have served as a good diversification instrument against bad stock market outcomes, and that such diversification benefits have been relatively stronger following periods with higher realized stock volatility. When the stock return was extreme, they found a sizably opposite average Treasury bond return.

The authors concluded: “The intertemporal aspect of our findings supports the notion that equity volatility can help understand volatility behavior in bond markets, beyond an approach that only looks at the bond market in isolation.”

Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.

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