Characterizing the Co-Movement of the Stock and Bond Markets
44 Pages Posted: 3 Mar 2008 Last revised: 25 Nov 2008
Date Written: February 2008
This paper documents a negative relation between the volatility of the U.S. stock market and the covariance of the U.S. stock and bond markets when the stock market is highly volatile. Cash-flow effect, compared with risk-premium effect, contributes substantially to this relation. During a volatile period, a decrease in expected future dividend growth rates induces a considerable decline in the covariance and a significant increase in stock market uncertainty. However, this negative relation has been pronounced only in the last two decades, not in the 1960s and 1970s. The fact that the inflation rate is high and volatile during the first subperiod but stays low and stable in the second subperiod causes this different relation.
Keywords: time-varying covariance, stock market, bond market
JEL Classification: G10
Suggested Citation: Suggested Citation