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Report
Nonlinearity and flight to safety in the risk-return trade-off for stocks and bonds
We document a highly significant, strongly nonlinear dependence of stock and bond returns on past equity market volatility as measured by the VIX. We propose a new estimator for the shape of the nonlinear forecasting relationship that exploits additional variation in the cross section of returns. The nonlinearities are mirror images for stocks and bonds, revealing flight to safety: expected returns increase for stocks when volatility increases from moderate to high levels, while they decline for Treasury securities. These findings provide support for dynamic asset pricing theories where the ...
Journal Article
Policy Instability and the Risk-Return Trade-Off
What is the impact of large swings in economic policy on the risk-return trade-off faced by investors? What is the impact of changes in policy regimes on investment strategies? In this paper we study the impact on returns of switches between periods of market-friendly economic policies and periods of populist policies. To quantify the impact of policy instability, we use data from Argentina—a country that has experienced frequent and very large regime changes—and find that the risk-return for individual assets and minimum variance portfolios are quite different across regimes. We then ...