Hostname: page-component-586b7cd67f-g8jcs Total loading time: 0 Render date: 2024-12-04T20:14:27.011Z Has data issue: false hasContentIssue false
  • English
  • Français

Risk Premia and the Dynamic Covariance between Stock and Bond Returns

Published online by Cambridge University Press:  06 April 2009

John T. Scruggs  and
Paskalis Glabadanidis
John T. Scruggs
Affiliation:
[email protected], Terry College of Business, University of Georgia, Brooks Hall, Athens, GA 30602;
Paskalis Glabadanidis
Affiliation:
[email protected], Onlin School of Business, Washington University in St.Louis, Campus Box 1133, One Brookings Drive, St.Louis, MO 63130.
Get access Rights & Permissions [Opens in a new window]

Abstract

We investigate whether intertemporal variation in stock and bond risk premia can be explained by time-varying covariances with priced risk factors. We estimate and test a conditional two-factor variant of Merton's ICAPM in which excess returns on an equity index and a long-term government bond portfolio proxy for risk factors. Conditional second moments follow the asymmetric dynamic covariance (ADC) model of Kroner and Ng (1998). We find that conditional bond variance responds symmetrically to bond return shocks but is virtually unaffected by stock return shocks, while conditional stock variance responds asymmetrically to both stock and bond return shocks. Models that impose a constant correlation restriction on the covariance matrix between stock and bond returns are strongly rejected. We conclude that the conditional two-factor model fails to adequately explain intertemporal variation in stock and bond risk premia.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 38 , Issue 2 , June 2003 , pp. 295 - 316
Copyright
Copyright © School of Business Administration, University of Washington 2003

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Backus, D. K. and Gregory, A. W.. “Theoretical Relations between Risk Premiums and Conditional Variances.” Journal of Business and Economic Statistics, 11 (1993), 177–185.CrossRefGoogle Scholar
Baillie, R. T. and DeGennaro, R. P.. “Stock Returns and Volatility.” Journal of Financial and Quantitative Analysis, 25 (1990), 203–214.CrossRefGoogle Scholar
Bekaert, G. and Wu, G.. “Asymmetric Volatility and Risk in Equity Markets.” Review of Financial Studies, 13 (2000), 1–41.CrossRefGoogle Scholar
Berndt, E. R.Hall, B. H.Hall, R. E. and Hausman, J. A.. “Estimation and Inference in Nonlinear Structural Models.” Annals of Economic and Social Measurement, 3 (1974), 653–665.Google Scholar
Bollerslev, T. “Modeling the Coherence in Short-Run Nominal Exchange Rates: A Multivariate Generalized ARCH Approach.” Review of Economics and Statistics, 72 (1990), 498–505.CrossRefGoogle Scholar
Bollerslev, T. and Wooldridge, J. M.. “Quasi-Maximum Likelihood Estimation and Inference in Dynamic Models with Time-Varying Covariances.” Econometric Reviews, 11 (1992), 143–172.CrossRefGoogle Scholar
Breen, W.Glosten, L. R. and Jagannathan, R.. “Economic Significance of Predictable Variations in Stock Index Returns.” Journal of Finance, 44 (1989), 1177–1189.CrossRefGoogle Scholar
Campbell, J. Y. “Stock Returns and the Term Structure.” Journal of Financial Economics, 18 (1987), 373–399.CrossRefGoogle Scholar
Campbell, J. Y. and Hentschel, L.. “No News is Good News: An Asymmetric Model of Changing Volatility in Stock Returns.” Journal of Financial Economics, 31 (1992), 281–318.CrossRefGoogle Scholar
Chauvet, M. and Potter, S.. “Nonlinear Risk.” Macroeconomic Dynamics, 5 (2001), 621–646.CrossRefGoogle Scholar
Chen, N.-F.Roll, R. and Ross, S. A.. “Economic Forces and the Stock Market.” Journal of Business, 59 (1986), 383–403.CrossRefGoogle Scholar
Corana, A. and Marchesi, M. and Martini, C. and Ridella, S.. “Minimizing Multimodal Functions of Continuous Variables with the ‘Simulated Annealing’ Algorithm.” ACM Transactions on Mathematical Software, 13 (1987), 262–280.CrossRefGoogle Scholar
De Santis, G. and Gérard, B.. “How Big is the Premium for Currency Risk?” Journal of Financial Economics, 49 (1998), 375–412.CrossRefGoogle Scholar
Engle, R. F. and Kroner, K. F.. “Multivariate Simultaneous Generalized ARCH.” Econometric Theory, 11 (1995), 122–150.CrossRefGoogle Scholar
Engle, R. F. and Ng, V. K.. “Measuring and Testing the Impact of News on Volatility.” Journal of Finance, 48 (1993), 1749–1778.CrossRefGoogle Scholar
Evans, M. D. D. “Expected Returns, Time-Varying Risk, and Risk Premia.” Journal of Finance, 49 (1994), 655–679.Google Scholar
Fama, E. F. and French, K. R.. “Dividend Yields and Expected Stock Returns.” Journal of Financial Economics, 22 (1988), 3–25.CrossRefGoogle Scholar
Fama, E. F. and French, K. R.. “Business Conditions and Expected Returns on Stocks and Bonds.” Journal of Financial Economics, 25 (1989), 23–49.CrossRefGoogle Scholar
Fama, E. F. and French, K. R.. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics, 33 (1993), 3–56.CrossRefGoogle Scholar
Fama, E. F. and Schwert, G. W.. “Asset Returns and Inflation.” Journal of Financial Economics, 5 (1977), 115–146.CrossRefGoogle Scholar
Ferson, W. E. “Changes in Expected Security Returns, Risk, and the Level of Interest Rates.” Journal of Finance, 44 (1989), 1191–1217.CrossRefGoogle Scholar
French, K. R.Schwert, G.W. and Stambaugh, R. F.. “Expected Stock Returns and Volatility.” Journal of Financial Economics, 19 (1987), 3–29.CrossRefGoogle Scholar
Glosten, L. R.Jagannathan, R. and Runkle, D. E.. “On the Relation between the Expected Value and the Volatility of the Nominal Excess Return on Stocks.” Journal of Finance, 48 (1993), 1779–1801.CrossRefGoogle Scholar
Goffe, W. L.Ferrier, G. D. and Rogers, J.. “Global Optimization of Statistical Functions with Simulated Annealing.” Journal of Econometrics, 60 (1994), 65–99.CrossRefGoogle Scholar
Harrison, P. and Zhang, H. H.. “An Investigation of the Risk and Return Relation at Long Horizons.” Review of Economics and Statistics, 81 (1999), 399–408.CrossRefGoogle Scholar
Harvey, C. R. “Time-Varying Conditional Covariances in Tests of Asset Pricing Models.” Journal of Financial Economics, 24 (1989), 289–317.CrossRefGoogle Scholar
He, J.Kan, R.Ng, L. and Zhang, C.. “Tests of the Relations amongMarketwide Factors, Firm-Specific Variables, and Stock Returns Using a Conditional Asset Pricing Model.” Journal of Finance, 51 (1996), 1891–1908.Google Scholar
Ibbotson Associates. Stocks, Bonds, Bills and Inflation 1998 Yearbook. Chicago, IL: Ibbotson Associates (1998).Google Scholar
Keim, D. B. and Stambaugh, R. F.. “Predicting Returns in the Stock and Bond Markets.” Journal of Financial Economics, 17 (1986), 357–390.CrossRefGoogle Scholar
Kroner, K. F. and Ng, V. K.. “Modeling Asymmetric Comovements of Asset Returns.” Review of Financial Studies, 11 (1998), 817–844.CrossRefGoogle Scholar
Ljung, G. M. and Box, G. E. P.. “On a Measure of Lack of Fit in Time Series Models.” Biometrika, 65 (1978), 297–303.CrossRefGoogle Scholar
Mayfield, E. S. “Estimating the Market Risk Premium.” Working Paper 00–037, Harvard Business School (1999).CrossRefGoogle Scholar
Merton, R. C. “An Intertemporal Asset Pricing Model.” Econometrica, 41 (1973), 867–887.CrossRefGoogle Scholar
Nelson, D. B. “Conditional Heteroskedasticity in Asset Returns: A New Approach.” Econometrica, 59 (1991), 347–370.CrossRefGoogle Scholar
Pagan, A. R. and Hong, Y. S.. “Nonparametric Estimation and the Risk Premium.” In Semiparametric and Nonparametric Methods in Econometrics and Statistics, Barnett, W. A.Powell, J. and Tauchen, G. E., eds. Cambridge, England: Cambridge Univ. Press (1989), 51–75.Google Scholar
Schwert, G. W. “Why Does Stock Market Volatility Change over Time?” Journal of Finance, 44 (1989), 1115–1153.CrossRefGoogle Scholar
Scruggs, J. T. “Resolving the Puzzling Intertemporal Relation between the Market Risk Premium and Conditional Market Variance: A Two-Factor Approach.” Journal of Finance, 53 (1998), 575–603.CrossRefGoogle Scholar
Shanken, J. “Intertemporal Asset Pricing: An Empirical Investigation.” Journal of Econometrics, 45 (1990), 99–120.CrossRefGoogle Scholar
Turner, C. M.Startz, R. and Nelson, C. R.. “A Markov Model of Heteroskedasticity, Risk, and Learning in the Stock Market.” Journal of Financial Economics, 25 (1989), 3–22.CrossRefGoogle Scholar
Turtle, H.Buse, A. and Korkie, B.. “Tests of Conditional Asset Pricing with Time-Varying Moments and Risk Prices.” Journal of Financial and Quantitative Analysis, 29 (1994), 15–29.CrossRefGoogle Scholar
Veronesi, P. “How Does Information Quality Affect Stock Returns?” Journal of Finance, 55 (2000), 807–837.CrossRefGoogle Scholar
Whitelaw, R. F. “Time Variations and Covariations in the Expectation and Volatility of Stock Market Returns.” Journal of Finance, 49 (1994), 515–541.CrossRefGoogle Scholar
Whitelaw, R. F.. “Stock Market Risk and Return: An Equilibrium Approach.“ Review of Financial Studies, 13 (2000), 521–547.CrossRefGoogle Scholar