Dynamics among the term spread, stock market volatility forecast, financial market risk and oil price: an empirical analysis

Abstract The term spread is viewed as a leading indicator for predicting stock market volatility. The safe haven hypothesis argues that rising stock market volatility may increase the demand for Treasury-issued bonds, thereby lowering the term spread. This research proposes a synthesis of these two opposing views, hypothesizing a long run common trend between the term spread and stock market volatility. Financial market risk and oil prices also impact stock market volatility. This research uses monthly time series data from 1990 to 2020 of the CBOE volatility index, term spread, financial market risk index, and oil price. Our estimations find evidence of cointegration between the term spread and stock market volatility via the’bounds test’ in an ARDL framework, confirming our hypothesis. The simulated impulse responses indicate that stock market volatility increases with a shock to financial market risk and oil price growth but does not change with a shock to the term spread.