Volatility linkages of the equity, bond and money markets: an implied volatility approach

Author: Wang, Kent

Source: Accounting and Finance, Volume 49, Number 1, March 2009 , pp. 207-219(13)

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Abstract:

This study proposes an alternative approach for examining volatility linkages between Standard & Poor's 500, Eurodollar futures and 30 year Treasury Bond futures markets using implied volatility from the three markets. Simple correlation analysis between implied volatilities in the three markets is used to assess market correlations. Spurious correlation effects are considered and controlled for. I find that correlations between implied volatilities in the equity, money and bond markets are positive, strong and robust. Furthermore, I replicate the approach of Fleming, Kirby and Ostdiek (1998) to check the substitutability of the implied volatility approach and find that the results are nearly identical; I conclude that my approach is simple, robust and preferable in practice. I also argue that the results from this paper provide supportive evidence on the information content of implied volatilities in the equity, bond and money markets.

Keywords: Volatility linkage; Information linkage; Implied volatility; Spurious regression; Generalized method of moments; G12; G14

Document Type: Research article

DOI: http://dx.doi.org/10.1111/j.1467-629X.2008.00281.x

Affiliations: 1: UQ Business School, University of Queensland, Brisbane, 4072, Australia

Publication date: 2009-03-01