Staff Reports
Nonlinearity and Flight to Safety in the
Risk-Return Trade-Off for Stocks and Bonds
April 2015 Number 723
Revised November 2017
JEL classification: G01, G12, G17

Authors: Tobias Adrian, Richard Crump, and Erik Vogt

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 price of risk is a nonlinear function of market volatility.

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