Dynamics of Bond and Stock Returns

62 Pages Posted: 18 Apr 2015 Last revised: 31 Jan 2019

See all articles by Serhiy Kozak

Serhiy Kozak

University of Maryland - Robert H. Smith School of Business

Date Written: January 30, 2019

Abstract

I present a production-based general equilibrium model that jointly prices bond and stock returns. The model produces time-varying correlation between stock and long-term default-free real bond returns that changes in both magnitude and sign. The real term premium is also time-varying and changes sign. To generate these results, the model incorporates time-varying risk aversion within Epstein-Zin preferences and two physical technologies with different exposure to cash-flow risk. Bonds hedge risk-aversion (discount-rate) shocks and command negative term premium through this channel. Capital (cash-flow) shocks produce comovement of bond and stock returns and positive term premium. The relative strength of these two mechanisms varies over time.

Keywords: bonds, stocks, risk premium, general equilibrium

JEL Classification: E44

Suggested Citation

Kozak, Serhiy, Dynamics of Bond and Stock Returns (January 30, 2019). Ross School of Business Paper No. 1277. Available at SSRN: https://ssrn.com/abstract=2595352 or http://dx.doi.org/10.2139/ssrn.2595352

Serhiy Kozak (Contact Author)

University of Maryland - Robert H. Smith School of Business ( email )

7621 Mowatt Ln
College Park, MD 20742
United States

HOME PAGE: http://https://serhiykozak.com

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