Bond variance risk premia

Philippe Mueller (), Andrea Vedolin and Yu-Min Yen

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: Using data from 1983 to 2010, we propose a new fear measure for Treasury markets, akin to the VIX for equities, labeled TIV. We show that TIV explains one third of the time variation in funding liquidity and that the spread between the VIX and TIV captures flight to quality. We then construct Treasury bond variance risk premia as the difference between the implied variance and an expected variance estimate using autoregressive models. Bond variance risk premia display pronounced spikes during crisis periods. We show that variance risk premia encompass a broad spectrum of macroeconomic uncertainty. Uncertainty about the nominal and the real side of the economy increase variance risk premia but uncertainty about monetary policy has a strongly negative effect. We document that bond variance risk premia predict excess returns on Treasuries, stocks, corporate bonds and mortgage-backed securities, both in-sample and out-of-sample. Furthermore, this predictability is not subsumed by other standard predictors.

Keywords: variance risk premium; treasury implied volatility; predictability; uncertainty; treasury bond returns; stock returns; corporate bond returns (search for similar items in EconPapers)
JEL-codes: E43 E47 G12 (search for similar items in EconPapers)
Pages: 51 pages
Date: 2012-01-01
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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http://eprints.lse.ac.uk/119053/ Open access version. (application/pdf)

Related works:
Working Paper: Bond Variance Risk Premia (2012)
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