Equity volatility, bond yields, and yield spreads

Abstract

AbstractThis study examines the impact of implied and contemporaneous equity market volatility on Treasury yields, corporate bond yields, and yield spreads over Treasuries. The CBOE VIX is the measure of implied volatility, and the measure of contemporaneous volatility is constructed using intraday squared S&P 500 returns. We find that bond yields and spreads respond to changes in equity market volatility in a manner consistent with a flight‐to‐quality effect. Both short‐ and long‐term Treasury yields fall in response to increases in implied volatility, and the yield curve flattens modestly. Yields on short‐term investment grade bonds fall in response to contemporaneous volatility shocks, while long‐term spreads on low‐quality issues widen. This indicates that investors “look ahead” in anticipation of changes in equity market volatility but respond more strongly to changes in contemporaneous market activity. © 2011 Wiley Periodicals, Inc. Jrl Fut Mark