The Economic Value of Volatility Transmission between the Stock and Bond Markets
29 Pages Posted: 17 Oct 2006
Date Written: January 2007
The objective of this paper is to analyze volatility transmission between stocks and bonds in the European market in an attempt to establish whether the observed pattern in volatility can be exploited economically. In order to do so, firstly, we use an asymmetric multivariate GARCH model that allows for asymmetries in second moments. Secondly, we design a trading rule to dynamically allocate capital between equities and bonds. The results indicate that volatility spillovers between both assets take place in both directions. Moreover, these volatility spillovers are economically significant since trading rules based on them offer profitable returns after transaction costs. This last fact could suggest a failure of the efficient market hypothesis.
Keywords: Volatility Spillovers, GARCH, Trading Rules
JEL Classification: C32, C53, G11
Suggested Citation: Suggested Citation