Modeling the Joint Dynamics of Risk-Neutral Stock Index and Bond Yield Volatilities

37 Pages Posted: 1 Mar 2014

See all articles by Yinggang Zhou

Yinggang Zhou

Xiamen University - Department of Finance

Date Written: September 10, 2013

Abstract

This study examines the joint evolution of risk-neutral stock index and bond yield volatilities by using the Chicago Board Option Exchange S&P500 volatility index (VIX) and the Bank of America Merrill Lynch Treasury Option Volatility Estimate Index (MOVE). I use bivariate regime-switching models to investigate the alternation of “high-risk” and “low-risk” markets, where the high-risk regime is characterized by higher volatilities and stronger cross-market linkages. Common information about economic and financial conditions appears to drive VIX and MOVE fluctuations between the two risk regimes. Two-regime specifications also distinguish between information spillover and common information effects. Ignoring regime shifts leads to spurious extreme persistence and incomplete inferences about asymmetric volatility. The findings carry important implications for asset allocation.

Keywords: option-implied volatility, VIX, MOVE, common information, information spillover, regime switch

JEL Classification: G11, G12, C32

Suggested Citation

Zhou, Yinggang, Modeling the Joint Dynamics of Risk-Neutral Stock Index and Bond Yield Volatilities (September 10, 2013). Journal of Banking and Finance, Vol. 38, No. 1, 2014, Available at SSRN: https://ssrn.com/abstract=2402520

Yinggang Zhou (Contact Author)

Xiamen University - Department of Finance ( email )

Xiamen, Fujian 361005
China

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