Flights to Safety and Volatility Pricing

Unexpected shifts in the realized stock market volatility, often associated with financial crises, carry a significantly negative risk premium across stocks and Treasuries, which suggests the existence of a unified pricing model. 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. This is consistent with investors' "flights to safety", and the corresponding change in sign in the stock-bond correlation, during times of economic uncertainty. Furthermore, because of their positive loadings on volatility, bonds perform well in bad times, which explains their lower expected returns. Interestingly, the joint pricing of stocks and Treasuries leads to economically meaningful and statistically significant risk premia estimates, and to a good performance of asset pricing models. In contrast, both the implied volatility index, VIX, and the tail index, SKEW, are not robustly priced across the two financial markets