Stock Implied Volatility, Stock Turnover, and the Stock-Bond Return Relation

Abstract

The authors study time-variation in the co-movements between daily stock and Treasury bond returns over 1986 to 2000. Their innovation is to examine whether variation in stock-bond return dynamics can be linked to non-return-based measures of stock market uncertainty, specifically the implied volatility (IV) from equity index options and detrended stock turnover (DTVR). The authors investigate two empirical questions suggested by recent literature on stock market uncertainty and cross-market hedging. First, from a forward-looking perspective, they find that the levels of IV and DTVR are both negatively associated with the future correlation between stock and bond returns. The probability of a negative correlation between daily stock and bond returns over the next month is several times greater following relatively high values of IV and DTVR. Second, from a contemporaneous perspective, the authors find that bond returns tend to be relatively high (low) during days when IV increases (decreases) and during days when stock turnover is unexpectedly high (low). Their findings suggest that stock market uncertainty has cross-market pricing influences that play an important role in understanding joint stock-bond price formation. Further, our results imply that stock-bond diversification benefits increase with stock market uncertainty.