Volatility Pricing in the Stock and Treasury Markets

Unexpected shifts in stock market volatility, often associated with financial crises, carry a significantly negative risk premium across the stock and Treasury markets, which suggests the existence of a unified pricing model for these markets. Results show that investors require a premium for holding the risky assets (stocks), which correlate negatively to volatility surprises, while they are willing to pay a premium for holding the safe assets (Treasury bonds), which correlate positively (the so-called "flight-to-safety"). Interestingly, when I break down stocks into large-cap and small-cap, I find that the former have a greater ability to weather volatility surprises, which partially accounts for their lower expected returns.