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Equity return and short-term interest rate volatility: level effects and asymmetric dynamics

Henry, Olan T. ; OLEKALNS, NILSS ; Suardi, Sandy ( 2005-07)

Evidence suggests that short-term interest rate volatility peakswith the level of short rates, while equity volatility responds asymmetricallyto positive and negative shocks. We present an LM basedtest that distinguishes between level effects and asymmetry in volatilitywhich is robust to the presence of unidentified nuisance parametersunder the null. There is strong evidence of a level effect and asymmetricresponse in the relationship between S&P 500 Index returns and3-month US Treasury Bills. The conditional covariance depends onthe level of the short rate which has implications for hedging equityreturns against short term interest rate movements.
Testing for asymmetry in interest rate volatility in the presence of a neglected level effect

HENRY, OT ; SUARDI, S (Department of Economics, The University of Melbourne, 2005)