A two-factor no-arbitrage model is used to provide a theoretical link between stock and bond market volatility. While this model suggests that short-term interest rate volatility may, at least in part, drive both stock and bond market volatility, the empirical evidence suggests that past bond market volatility affects both markets and feeds back into short-term yield volatility. The empirical modelling goes on to examine the (time-varying) correlation structure between volatility in the stock and bond markets and finds that the sign of this correlation has reversed over the last 20 years. This has important implications far portfolio selection in financial markets. © 2005 Elsevier B.V. All rights reserved.
|Number of pages||16|
|Journal||Journal of International Financial Markets, Institutions and Money|
|Publication status||Published - Feb 2006|
Bibliographical noteNOTICE: this is the author’s version of a work that was accepted for publication in Journal of International Financial Markets, Institutions and Money. Changes resulting from the publishing process, such as peer review, editing, corrections, structural formatting, and other quality control mechanisms may not be reflected in this document. Changes may have been made to this work since it was submitted for publication. A definitive version was subsequently published in Steeley, James M. (2006). Volatility transmission between stock and bond markets. Journal of International Financial Markets, Institutions and Money, 16 (1), pp. 71-86. DOI 10.1016/j.intfin.2005.01.001