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On the Economic Determinants of Optimal Stock-Bond Portfolios: International Evidence

Updated version of: University of Heidelberg, Department of Economics, Discussion Paper Series No. 636

54 Pages Posted: 19 Jul 2017 Last revised: 11 Dec 2017

Christian Conrad

University of Heidelberg - Faculty of Economics and Social Studies

Karin Stürmer

Northwestern University - Kellogg School of Management

Date Written: November 6, 2017

Abstract

Using a modified DCC-MIDAS specification that allows the long-term correlation component to be a function of multiple explanatory variables, we show that the stock-bond correlation in the US, the UK, Germany, France, and Italy is mainly driven by inflation and interest rate expectations as well as a flight-to-safety during times of stress in financial markets. Based on covariance forecasts from the new specification, we construct stock-bond hedge portfolios and show that these portfolios outperform various benchmark portfolios in terms of portfolio risk. While optimal daily weights minimize portfolio risk, we find that portfolio turnover and trading costs can be substantially reduced when switching to optimal monthly weights.

Keywords: stock-bond correlation, DCC, DCC-MIDAS, survey data, macro expectations, forecasting, portfolio choice, asset allocation

JEL Classification: C32, C58, E44, E52, G11, G15, G17

Suggested Citation

Conrad, Christian and Stürmer, Karin, On the Economic Determinants of Optimal Stock-Bond Portfolios: International Evidence (November 6, 2017). Updated version of: University of Heidelberg, Department of Economics, Discussion Paper Series No. 636. Available at SSRN: https://ssrn.com/abstract=3002664

Christian Conrad

University of Heidelberg - Faculty of Economics and Social Studies ( email )

Bergheimer Strasse 58
Heidelberg, D-69115
Germany
+49 (0)6221 54 3173 (Phone)

HOME PAGE: http://www.uni-heidelberg.de/fakultaeten/wiso/awi/professuren/empwirtfor/christianconrad.html

Karin Stürmer (Contact Author)

Northwestern University - Kellogg School of Management ( email )

2211 Campus Drive
Evanston, IL 30208
United States

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