Understanding Asset Correlations

64 Pages Posted: 6 Jul 2011 Last revised: 12 Dec 2012

See all articles by Henrik Hasseltoft

Henrik Hasseltoft

affiliation not provided to SSRN

Dominic Burkhardt

University of Zurich/Swiss Finance Institute

Date Written: September 30, 2012

Abstract

We document an inverse relation between stock-bond correlations and correlations of growth and inflation. We find that rising inflation uncertainty lowers stock prices but can either lower or raise nominal bond prices depending on whether inflation is counter- or procyclical. We show that the time-varying comovement of growth and inflation has important implications for how inflation impacts asset prices. We explain our findings in a long-run risk model with non-neutral inflation shocks and regime shifts, allowing for countercyclical and procyclical inflation regimes. The model can produce an upward-sloping real yield curve and rationally explains the so-called Fed-model. Finally, inflation and monetary policy shocks were important drivers of stock-bond correlations during the countercyclical period 1965-2000 while output shocks dominated during the procyclical period 2000-2011.

Keywords: cyclicality, fed-model, inflation, long-run risks, money illusion, regime-switching, stock-bond correlation

JEL Classification: E43, E44, G12

Suggested Citation

Hasseltoft, Henrik and Burkhardt, Dominic, Understanding Asset Correlations (September 30, 2012). Swiss Finance Institute Research Paper No. 12-38, Available at SSRN: https://ssrn.com/abstract=1879855 or http://dx.doi.org/10.2139/ssrn.1879855

Henrik Hasseltoft (Contact Author)

affiliation not provided to SSRN

Dominic Burkhardt

University of Zurich/Swiss Finance Institute ( email )

Rämistrasse 71
Zürich, CH-8006
Switzerland

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