Rate Risk and Rate Insurance

Olivier Wang

No 35636, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: I decompose stock returns into a duration-matched Treasury component, identified from monetary policy surprises, and a payoff component. Risk and returns rise much less with duration for stocks than for their matched Treasuries. Stock volatility is dampened by rate insurance: rates fall in bad times, so the bond inside a stock provides insurance against the stock’s payoff risk. Expected stock returns are dampened because the insurance works in reverse: rates rise in good times, so stocks’ payoff gains hedge the losses borne by investors holding net duration, notably government bonds when Ricardian equivalence fails. This framework helps reconcile positive bond premia with negative stock-bond covariance, sheds light on equity anomalies and the collapse of the value premium, implies that fiscal and monetary policy shape bond and equity premia, and motivates a two-factor model that jointly prices stocks and bonds. Rate insurance can even turn the price of long-run risk negative, explaining why long bonds beat long stocks.

Date: 2026-08
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