The Stock-Bond Correlation

22 Pages Posted: 12 May 2020

See all articles by Megan Czasonis

Megan Czasonis

State Street Corporate

Mark Kritzman

Windham Capital Management

David Turkington

State Street Associates

Date Written: April 27, 2020

Abstract

Investors rely on the stock-bond correlation for a variety of tasks, such as forming optimal portfolios, designing hedging strategies, and assessing risk. Most investors estimate the stock-bond correlation simply by extrapolating the historical correlation of monthly returns and assume that this correlation best characterizes the correlation of future, annual or multi-year returns, but this approach is decidedly unreliable. The authors introduce four innovations for generating a reliable prediction of the stock-bond correlation. First, they show how to represent the correlation of single period cumulative stock and bond returns in a way that captures how the returns drift during the period. Second, they identify fundamental predictors of the stock-bond correlation. Third, they model the stock-bond correlation as a function of the path of some fundamental predictors rather than single observations. And fourth, they censor their sample to include only relevant observations, in which relevance has a precise mathematical definition.

Keywords: Autocorrelation, Henriksson-Merton test, Informativeness, Lagged cross-correlation, Mahalanobis distance, Partial sample regression, Relevance, Single period correlation, Statistical similarity

JEL Classification: C00, C01, C02, C22, C58, C65, G11, G17

Suggested Citation

Czasonis, Megan and Kritzman, Mark and Turkington, David, The Stock-Bond Correlation (April 27, 2020). MIT Sloan Research Paper No. 6108-20, Available at SSRN: https://ssrn.com/abstract=3595566 or http://dx.doi.org/10.2139/ssrn.3595566

Megan Czasonis

State Street Corporate ( email )

1 Lincoln Street
Boston, MA 02111
United States

Mark Kritzman (Contact Author)

Windham Capital Management ( email )

800 Boylston Street
30th Floor
Boston, MA 02199
United States
6174193900 (Phone)
6172365034 (Fax)

David Turkington

State Street Associates ( email )

United States

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