The U.S. term structure and return volatility in emerging stock markets
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The U.S. term structure and return volatility in emerging stock markets Riza Demirer 1
& Asli
Yuksel 2 & Aydin Yuksel 3
# Academy of Economics and Finance 2020
Abstract This paper examines the predictive power of the U.S. term structure over return volatility in emerging stock markets. Decomposing the term structure of U.S. Treasury yields into two components, the expectations factor and the maturity premium, we show that the U.S. term structure indeed contains predictive information over emerging stock market volatility, even after controlling for country specific factors including turnover and market size. While we observe heterogeneous patterns across emerging markets in terms of their predictability with respect to the U.S. term structure, we find that the market’s expectation of future short term rates, implied by the expectations factor, serves as a stronger predictor of stock market volatility compared to the maturity premium component of the yield spread. We also find that the U.S. term structure has gained further predictive value following the global financial crisis, particularly for the BRICS nations of China, Russia, and S. Africa. Overall, our findings suggest that policymakers and investors can utilize interest rate signals from the U.S. Treasury yields to make projections over stock market volatility in their local markets, however, distinguishing between the two components of the yield curve could provide additional forecasting power depending on the country of focus. Keywords Term structure of interest rates . Stock market volatility, expectations factor .
Maturity premium JEL classification G14 . G15 . G11
* Aydin Yuksel [email protected] Riza Demirer [email protected] Asli Yuksel [email protected] Extended author information available on the last page of the article
Journal of Economics and Finance
1 Introduction Fueled by the liberalization of economies in developing regions and rise in the level of economic integration, cross-border capital flows have played an increasing role in driving return dynamics in emerging stock markets, often presenting challenges for policy makers in those nations (e.g. Henry 1998; Bekaert et al. 2002, among others). While one strand of the literature highlights the role of country-specific factors in attracting foreign flows (e.g. Chuhan et al. 1998), other studies point to the role of U.S. monetary policy as a major driver of capital flows into emerging economies (e.g. Taylor and Sarno 1997; De Vita and Kyaw 2008). Indeed, a growing number of studies argue the presence of a global financial cycle to describe patterns in global capital flows and prices across countries (Nier et al. 2014) for which the monetary policy by the U.S. Fed serves as a major driver (e.g. Passari and Rey 2015; Rey 2016, 2018). This evidence further supports the earlier findings that the Fed’s interest rate policies can be a determinant of financial conditions in foreign markets (Miranda-Agrippino and Rey 2015; Bruno and Shin 2015). Given the role of U.S. monetary p
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