Trends in Stock-Bond Correlations
AJRC Working Paper 03/2015, October 2015, ISBN 978-0-86413-014-3
32 Pages Posted: 3 Aug 2017
Date Written: October 1, 2015
Previous research document the existence of long-run trends in comovements in the stock and bond markets. Following these findings, this paper examines possible trends in stock- bond return correlations. To this end, we introduce a trend component into a smooth transition regression (STR) model including the multiple transition variables of Aslanidis and Christiansen (2012). The results indicate the existence of significant decreasing trends in stock-bond correlations for many advanced safer countries. In addition, although stock market volatility continues to be an important factor in stock-bond correlations, the short rate and yield spread become only marginally significant once we introduce the trend component. Our out-of-sample analysis also demonstrates that the STR model including the VIX and time trend as the transition variables dominates other models. Furthermore, we find a significant increase in stock-bond correlations for riskier Euro countries around the beginning of the Euro crisis. Our findings of decreasing and increasing trends in stock-bond correlations can be considered a consequence of the decreasing effects of diversification and more intensive flight-to-quality behavior that have taken place in recent years and after the Euro crisis.
Keywords: Comovement, flight-to-quality, diversification effect, smooth transition
JEL Classification: C22, G15, G17
Suggested Citation: Suggested Citation