Macroeconomics Determinants of the Correlation Between Stocks and Bonds
43 Pages Posted: 31 Jul 2019
Date Written: November 6, 2018
We analyze the correlation between the stock and bond markets in Germany and the US. We use a standard no-arbitrage affine model to decompose the correlation between these two assets into its main drivers. The correlation between bond yields and stock returns is a key determinant of asset allocation. Our results show that the correlation is primarily influenced by the uncertainty about inflation and real interest rates as well as by co-movement between inflation, real interest rates and dividend growth. Shocks to inflation, real interest rates and dividend growth can explain the correlation’s temporary deviation from its long-term dynamics.
Keywords: bond market, stock market, macroeconomic shocks, money illusion
JEL Classification: C32, E43, G12
Suggested Citation: Suggested Citation