The Dynamic Correlation between Stock and Bond Returns: Evidence from the U.S. Market

Abstract

This paper investigates the correlation of returns between the U.S. stock and bond markets using two prominent index funds. By employing both rolling correlation and dynamic correlation coefficient models for the sample period from 1996 through 2008, we find that the correlation coefficients between stocks and bonds are time-varying and, on average, negative. The correlation coefficients between stock and bond markets depend on a few key macro state variables. The correlation coefficient is negatively correlated with the uncertainty of the stock market's performance but positively related to real income growth and the level of the federal funds rate.

Keywords: Stock-bond correlation,Volatility, DCC model, Fed model, Credit spread

JEL Classification: C12, C13, G10, G11