On the transmission channels between bond and stock market volatility

In this study, we examine whether the changes in the shape of the yield curve is a significant determinant of stock market volatility. Using the foundations of the dividend growth model, we extend the model to incorporate and relate the shape of the yield curve effects with the transmission from bond to equity market volatility. When including the risk premium and hedging premium components in our model, we theoretically show and empirically verify that the shape of the yield curve is a significant determinant of equity market volatility in major European equity markets. Finally, our forecasting models show that the shape of the yield curve contains significant forecasting power when used as predictor of European stock market volatility.