The Journal of Finance

Do Bonds Span Volatility Risk in the U.S. Treasury Market? A Specification Test for Affine Term Structure Models

Published: 03/19/2010   |   DOI: 10.1111/j.1540-6261.2009.01546.x

TORBEN G. ANDERSEN, LUCA BENZONI

We propose using model‐free yield quadratic variation measures computed from intraday data as a tool for specification testing and selection of dynamic term structure models. We find that the yield curve fails to span realized yield volatility in the U.S. Treasury market, as the systematic volatility factors are largely unrelated to the cross‐section of yields. We conclude that a broad class of affine diffusive, quadratic Gaussian, and affine jump‐diffusive models cannot accommodate the observed yield volatility dynamics. Hence, the Treasury market per se is incomplete, as yield volatility risk cannot be hedged solely through Treasury securities.

An Empirical Investigation of Continuous‐Time Equity Return Models

Published: 12/17/2002   |   DOI: 10.1111/1540-6261.00460

Torben G. Andersen, Luca Benzoni, Jesper Lund

This paper extends the class of stochastic volatility diffusions for asset returns to encompass Poisson jumps of time‐varying intensity. We find that any reasonably descriptive continuous‐time model for equity‐index returns must allow for discrete jumps as well as stochastic volatility with a pronounced negative relationship between return and volatility innovations. We also find that the dominant empirical characteristics of the return process appear to be priced by the option market. Our analysis indicates a general correspondence between the evidence extracted from daily equity‐index returns and the stylized features of the corresponding options market prices.

Portfolio Choice over the Life‐Cycle when the Stock and Labor Markets Are Cointegrated

Published: 09/04/2007   |   DOI: 10.1111/j.1540-6261.2007.01271.x

LUCA BENZONI, PIERRE COLLIN‐DUFRESNE, ROBERT S. GOLDSTEIN

We study portfolio choice when labor income and dividends are cointegrated. Economically plausible calibrations suggest young investors should take substantial short positions in the stock market. Because of cointegration the young agent's human capital effectively becomes “stock‐like.” However, for older agents with shorter times‐to‐retirement, cointegration does not have sufficient time to act, and thus their human capital becomes more “bond‐like.” Together, these effects create hump‐shaped life‐cycle portfolio holdings, consistent with empirical observation. These results hold even when asset return predictability is accounted for.