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It is widely acknowledged that the significant increase in the volatility of rates of returns on bonds during the early 1980s was a major factor in development of many of the bond derivative instruments and bond portfolio management techniques that sprang up in the late 1980s and early 1990s. Longstaff and Schwartz [1993] show that changes in bond market volatility are a major risk factor for bond investors. Dialynas and Edington [1992] contend that differences in bond market volatility can have a major impact on bond yield spreads. Authors including Dunetz and Mahoney [1988] and Fabozzi, Pitts, and Dattatreya [1997] show that the value of numerous fixedincome securities that include embedded options is heavily impacted by changes in bond return volatility.
While bond market volatility has subsided, we know very little about how much it has declined. Although bond price (return) volatility is critical to the analysis and management of bonds, there has been no detailed analysis of bond market volatility for the pre-1980 period that lets us put the experience of the 1980s and 1990s into perspective. To provide such perspective, it is essential to analyze intertemporal changes in bond return volatility for a long period.
We analyze the changing volatility of the government bond market over the past 50 years, and examine the relationship between bond market and stock market volatility. We document significant changes in volatility over time for the Treasury bond market. A comparison of bond market and stock market volatility shows that while both have experienced major changes in volatility over time, there is very little similarity in the patterns of volatility for the two markets. There are major differences in the time series for the two asset classes. These results have particular implications for analysts and bond portfolio managers.
LITERATURE REVIEW
There are many more studies of stock market volatility than bond market volatility.
Stock Market Volatility Studies
The earliest, rigorous study of stock market variability appears to be by Fisher and Lorie [1970] in a collection of studies on the variability of returns for stocks on the New York Stock Exchange. One segment of their study considers all stocks then on the NYSE and examines changes in the variance of this distribution of returns over time; it was...