Macroeconomics Determinants of the Correlation Between Stocks and Bonds

43 Pages Posted: 31 Jul 2019

Date Written: November 6, 2018

Abstract

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

Pericoli, Marcello, Macroeconomics Determinants of the Correlation Between Stocks and Bonds (November 6, 2018). Bank of Italy Temi di Discussione (Working Paper) No. 1198. Available at SSRN: https://ssrn.com/abstract=3429148 or http://dx.doi.org/10.2139/ssrn.3429148

Marcello Pericoli (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
00184 Roma
Italy

HOME PAGE: http://www.bancaditalia.it

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