  This paper quantifies the effects of equity tail risk on the US government
bond market. We estimate equity tail risk with option-implied stock market
volatility that stems from large negative price jumps, and we assess its value
in reduced-form predictive regressions for Treasury returns and a term
structure model for interest rates. We find that the left tail volatility of
the stock market significantly predicts one-month excess returns on Treasuries
both in- and out-of-sample. The incremental value of employing equity tail risk
as a return forecasting factor can be of economic importance for a
mean-variance investor trading bonds. The estimated term structure model shows
that equity tail risk is priced in the US government bond market and,
consistent with the theory of flight-to-safety, Treasury prices increase when
the perception of tail risk is higher. Our results concerning the predictive
power and pricing of equity tail risk extend to major government bond markets
in Europe.
