Daily Archives: Jun 25, 2021 at 07:01 pm EDT

Research Review | 25 June 2021 | Tail Risk

Equity Tail Risk in the Treasury Bond Market
Mirco Rubin (EDHEC) and Dario Ruzzi (Bank of Italy)
December 23, 2020
This paper quantifies the effects of equity tail risk on the US government bond market. We estimate equity tail risk as the option-implied stock market volatility that stems from large negative jumps as in Bollerslev, Todorov and Xu (2015), and assess its value in reduced-form predictive regressions for Treasury returns and an affine term structure model for interest rates. We document that the left tail volatility of the stock market significantly predicts one-month-ahead excess returns on Treasuries both in- and out-of-sample. The incremental value of employing equity tail risk as a return forecasting factor can be of economic importance for a mean-variance investor trading bonds. The estimated term structure model shows that equity tail risk is priced in the US government bond market. Consistent with the theory of flight-to-safety, we find that Treasury prices increase and funds flow from equities into bonds when the perception of tail risk is higher. Our results concerning the predictive power and pricing of equity tail risk extend to major government bond markets in Europe.

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Macro Briefing: 25 June 2021

* Biden, bipartisan group of senators agree on near-$1 trillion infrastructure bill
* US bans imports of China solar materials linked to forced labor
* Which China firms are the next to suffer from Beijing’s fintech crackdown?
* The enduring influence of Larry Summers’s views on US economics
* US jobless claims continued to drop last week
* Trade deficit for US widened in May
* Revised US GDP growth in Q1 unchanged at strong 6.4% increase
* US durable goods orders accelerated in May as new orders for planes rose: