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Nonlinearity and Flight‐to‐Safety in the Risk‐Return Trade‐Off for Stocks and Bonds

Tobias Adrian (), Richard Crump () and Erik Vogt

Journal of Finance, 2019, vol. 74, issue 4, 1931-1973

Abstract: We document a highly significant, strongly nonlinear dependence of stock and bond returns on past equity market volatility as measured by the VIX. We propose a new estimator for the shape of the nonlinear forecasting relationship that exploits variation in the cross‐section of returns. The nonlinearities are mirror images for stocks and bonds, revealing flight‐to‐safety: expected returns increase for stocks when volatility increases from moderate to high levels while they decline for Treasuries. These findings provide support for dynamic asset pricing theories in which the price of risk is a nonlinear function of market volatility.

Date: 2019
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https://doi.org/10.1111/jofi.12776

Related works:
Working Paper: Nonlinearity and flight to safety in the risk-return trade-off for stocks and bonds (2017) Downloads
Working Paper: Nonlinearity and Flight-to-Safety in the Risk-Return Tradeoff for Stocks and Bonds (2016) Downloads
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