Equity Return and Short-Term Interest Rate Volatility: Level Effects and Asymmetric Dynamics

Sandy Suardi, Ólan Henry and Nilss Olekalns ()

No 205, MRG Discussion Paper Series from School of Economics, University of Queensland, Australia

Abstract: Evidence suggests that short-term interest rate volatility peaks with the level of short rates, while equity volatility responds asymmetrically to positive and negative shocks. We present an LM based test that distinguishes between level effects and asymmetry in volatility which is robust to the presence of unidentified nuisance parameters under the null. There is strong evidence of a level effect and asymmetric response in the relationship between S&P 500 Index returns and 3-month US Treasury Bills. The conditional covariance depends on the level of the short rate which has implications for hedging equity returns against short term interest rate movements.

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Working Paper: Equity Return and Short-Term Interest Rate Volatility: Level Effects and Asymmetric Dynamics (2005)
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