Bond risk’s role in the equity risk-return tradeoff

Abstract

Recent research finds no appreciable or reliable linear relation between the VIX and the equity premium, but instead suggests a nonlinear linkage. We reexamine this risk-return issue in a multi-risk framework with VIX and T-bond risk (MOVE). We find that the partial relation between MOVE and the equity premium varies with economic conditions, especially becoming more negative in late 1997. Accounting for this economic variation uncovers a positive linear relation between the VIX and the equity premium, in a partial sense. Our results are robustly evident in alternative specifications and in subperiod analysis.