The Effects of Interest Rate Movements on Assets’ Conditional Second Moments

Abstract

This paper investigates whether the short term interest rate may explain the movements observed in the conditional second moments of asset returns. The theoretical connections between these seemingly unrelated quantities are studied within the C-CAPM framework. Under the assumption that the product of the relative risk aversion coefficient and the marginal utility is monotonic in consumption, original results are derived that attest the existence of a relation between the risk-free rate and the conditional second moments. The empirical findings, involving 165 stock returns quoted at the NYSE, confirm that, at low frequencies, the interest rate is a determinant of the 165 conditional variances and 13530 conditional correlations.