Common Shocks in Stocks and Bonds
90 Pages Posted: 27 Jun 2019 Last revised: 16 Nov 2020
Date Written: June 22, 2019
We propose an approach to identifying economic shocks (monetary, growth, and risk-premium news) from stock returns and Treasury yield changes, which allows us to study the drivers of asset prices at a daily frequency since the early 1980s. We apply the identification to examine investors’ responses to news from the Fed and key macro announcements. We uncover two risk-premium shocks—time-varying compensation for discount-rate and cash-flow news—which have distinct effects on stocks and bonds. Since the mid-1990s, the Fed-induced reductions in both risk premium sources have generated high average stock returns but an ambiguous response in bonds on FOMC days.
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