Economic-State Variation in the Post-1997 Relation between Equity Risk and T-bond Returns

58 Pages Posted: 20 Nov 2014 Last revised: 16 Jul 2018

See all articles by David A. Dubofsky

David A. Dubofsky

University of Louisville - Department of Finance

Chris T. Stivers

University of Louisville

Date Written: November 15, 2017

Abstract

Recent literature suggests an elevated hedging influence in T-bond pricing since the late 1990’s. Over 1997 to 2013, we find that the relation between T-bond pricing and equity risk has a strong economic-state contingency, one that supports and further qualifies the hedge premise over this period. Specifically, using a dual-risk framework with equity-index and T-bond implied volatilities, we find that the partial relation between T-bond returns and concurrent equity-risk innovations is several times stronger over a `late recession/early uncertain recovery' (LRER) segment of the economic cycle. LRER segments feature an elevated equity variance-risk premium, weak economic conditions, and lower consumer sentiment; characteristics suggestive of higher risk aversion. Intertemporally, also consistent with this hedge premise, we find that the partial predictive relation between equity-risk levels and subsequent T-bond excess returns is reliably negative over the economic cycles suggested by our LRER segments. Controlling for T-bond risk is important in establishing these findings.

Keywords: Equity risk, bond risk, Treasury bond returns, bond risk premia, hedging, risk aversion, economic states.

JEL Classification: G12

Suggested Citation

Dubofsky, David A. and Stivers, Chris T., Economic-State Variation in the Post-1997 Relation between Equity Risk and T-bond Returns (November 15, 2017). Available at SSRN: https://ssrn.com/abstract=2527213 or http://dx.doi.org/10.2139/ssrn.2527213

David A. Dubofsky

University of Louisville - Department of Finance ( email )

PO BOX 844000
Louisville, KY 40292
United States
502-852-3016 (Phone)
502-852-6072 (Fax)

HOME PAGE: http://cobweb2.louisville.edu/profile/Dubofsky.html

Chris T. Stivers (Contact Author)

University of Louisville ( email )

Finance Dept., College of Business
University of Louisville
Louisville, KY 40292
United States
502-852-4829 (Phone)

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