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Atlanta Fed Working Papers

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

Chris Stivers, Licheng Sun, and Robert Connolly
Working Paper 2002-3a
September 2002

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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.

JEL classification: G11, G12, G14

Key words: stock and bond market return linkages, stock implied volatility, stock turnover

An earlier version of this paper circulated under the title ?Stock Market Uncertainty and the Relation between Stock and Bond Returns.? The authors thank Jennifer Conrad, Jerry Dwyer, Mark Fisher, Paskalis Glabadanidis, Mark Kamstra, Bill Lastrapes, Marc Lipson, Joe Sinkey, Paula Tkac, and participants from seminars at the 2002 Western Finance Association meetings, the 2001 Atlanta Federal Reserve Bank?s All Georgia Conference, and the University of Georgia for comments and helpful discussions. The views expressed here are the authors? and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors? responsibility.

Please address questions regarding content to Chris Stivers, Department of Banking and Finance, Brooks Hall, Terry College of Business, University of Georgia, Athens, Georgia 30602 and Federal Reserve Bank of Atlanta (visiting scholar), 706-542-3648, 706-542-9434 (fax),; Licheng Sun, Department of Banking and Finance, Brooks Hall, Terry College of Business, University of Georgia, Athens, Georgia 30602, 706-542-3661, 706-542-9434 (fax),; or Robert Connolly, Department of Finance, Kenan-Flagler Business School, University of North Carolina at Chapel Hill, Chapel Hill, North Carolina 27599, 919-962-0053, 919-962-2068 (fax),

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