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Market Fragility and the Paradox of the Recent Stock-Bond Dissonance

38 Pages Posted: 11 Dec 2017  

Christos Koulovatianos

Universite du Luxembourg - Faculty of Law, Economics and Finance

Jian Li

Universite du Luxembourg

Fabienne Weber

Universite du Luxembourg - Department of Economics

Date Written: November 7, 2017

Abstract

After the Lehman-Brothers collapse, the stock index has exceeded its pre-Lehman-Brothers peak by 36% in real terms. Seemingly, markets have been demanding more stocks instead of bonds. Yet, instead of observing higher bond rates, paradoxically, bond rates have been persistently negative after the Lehman-Brothers collapse. To explain this paradox, we suggest that, in the post-Lehman-Brothers period, investors changed their perceptions on disasters, thinking that disasters occur once every 30 years on average, instead of disasters occurring once every 60 years. In our asset-pricing calibration exercise, this rise in perceived market fragility alone can explain the drop in both bond rates and price-dividend ratios observed after the Lehman-Brothers collapse, which indicates that markets mostly demanded bonds instead of stocks.

Keywords: Asset Pricing, Disaster Risk, Price-Dividend Ratio, Bond Returns

JEL Classification: G12, G01, E44, E43

Suggested Citation

Koulovatianos, Christos and Li, Jian and Weber, Fabienne, Market Fragility and the Paradox of the Recent Stock-Bond Dissonance (November 7, 2017). CFS Working Paper, No. 589, 2017. Available at SSRN: https://ssrn.com/abstract=3084155

Christos Koulovatianos (Contact Author)

Universite du Luxembourg - Faculty of Law, Economics and Finance ( email )

162a, avenue de la Faïencerie
Luxembourg-Limpertsberg, L-1511
Luxembourg

Jian Li

Universite du Luxembourg ( email )

L-1511 Luxembourg
Luxembourg

Fabienne Weber

Universite du Luxembourg - Department of Economics ( email )

Luxembourg

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