The US zero-coupon yield spread as a predictor of excess daily stock market volatility

Abstract

Slope of the yield curve has often been cited as an indicator of economic activity. Based on this premise, we extend the study to examine whether one can use the US zero-coupon yield spread to predict excess stock market volatility of three international stock markets – the United States, the United Kingdom and Hong Kong. By using daily trading data and changes in the US yield spread, our study entails four spread maturity spectrums, three stock markets, 7-trading day forecast horizons and four probit models. In the static models, we find evidence to support a US spread–volatility relationship in all three stock markets in the medium spread maturity up to 3 days ahead. In the dynamic models, although the predictive power of yield spread weakens slightly, the lagged dependent variable plays an important role.