What Ties Return Volatilities to Price Valuations and Fundamentals?
NBER Working Paper No. 15563
Stock and Treasury bond comovement, volatilities, and their relations to their price valuations and fundamentals change stochastically over time, both in magnitude and direction. These stochastic changes are explained by a general equilibrium model in which agents learn about composite economic and inﬂation regimes. We estimate our model using both fundamentals and asset prices, and ﬁnd that inﬂation news signal either positive or negative future real economic growth depending on the times, thereby affecting the direction of stock/bond comovement. The learning dynamics generate strong non-linearities between volatilities and price valuations. We ﬁnd empirical support for numerous predictions of the model.
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Published: Journal of Political Economy, Summer 2013, 121, 4, 682 - 746
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