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Keywords:

  • Comovement;
  • Fear Premium;
  • Flight-to-safety;
  • Flight-to-liquidity;
  • S&P 500 Earnings Yield;
  • Fed Model;
  • Required Yield;
  • Treasury Yields;
  • Federal Funds Rate;
  • Target;
  • Inflation Risk Premium;
  • G12

I develop a new risk measure called the Total Fear Premium that generalizes Faugere-Van Erlach (2009) and accounts for both flight-to-safety and flight-to-liquidity behavior. This new measure helps to explain why the daily S&P 500 forward earnings yield (E/P ratio) is strongly negatively correlated with daily Treasury yields of all maturities during the 2008 financial crisis, which is a reversal from the relation that prevailed before the crisis. The Total Fear Premium “mimics” the VIX during the financial crisis. Once the basic GARCH formulation modeling the interaction between the earnings yield and Treasury yields is augmented with the Total Fear Premium, the relation between the earnings yield and short-term Treasury yields becomes significantly positive, in line with Fama's (1975) view that short-term yields are good proxies for expected inflation. Two by-products of this analysis are: 1) a new risk premium measure associated with flight-to-liquidity and 2) a new way to measure the inflation risk premium on a daily basis.