Title: Equity tail risk in the treasury bond market
Authors: Mirco Rubin - EDHEC - Nice (France) [presenting]
Dario Ruzzi - Bank of Italy (Italy)
Abstract: The effects of equity tail risk on the US government bond market are quantified. We estimate equity tail risk with option-implied stock market volatility that stems from large negative price jumps and we assess its value in (i) reduced-form predictive regressions for Treasury returns, and (ii) an affine term structure model. We find that the left tail volatility of the stock market significantly predicts one-month excess returns on Treasuries both in- and out-of-sample. The incremental value of employing equity tail risk as a return forecasting factor can be of economic importance for a mean-variance investor trading bonds. The estimated term structure model shows that equity tail risk is priced in the US government bond market. Consistently with the theory of flight-to-safety, we find that when the perception of tail risk is higher (i) Treasury prices increase, and (ii) funds are flowing out of the equity market and (iii) into the bond market. Our results concerning the predictive power and pricing of equity tail risk extend to major government bond markets in Europe.