Two essays on treasury bond risks
Embargo Date
2024-05-10
OA Version
Citation
Abstract
Using a large panel of Treasury futures and options, I construct model-free measures of bond uncertainty and tail risks. In my first paper, I mainly study the behavior of bond risk measures around FOMC announcements and document three novel findings: First, bond uncertainty risk displays a rise and resolution similar to the stock VIX index, while tail risks don't respond to announcements. Second, pre-FOMC announcement drift exists in terms of Treasury yields declining by 1 bps on the day before the announcement. Third, option-implied uncertainty cannot help explain the pre-FOMC announcement drift.
In my second paper, I propose a new Flight-to-Safety (FTS) regime-switching model with time-varying stock-bond correlation and regime-switching probabilities. I document that the inclusion of higher-order moments such as tail risks is crucial to capturing Flight-to-Safety. In particular, higher bond tail risk lowers investors' intention to Flight-to-Safety. Time-varying tail risk correlation between stocks and bonds helps explain return correlation. Also, model estimates imply that FTS comprises 30% of the sample, which is significantly higher than the earlier work. I then apply my model with FTS probability-based asset allocation to prove that it significantly outperforms other models.