Empirical evidence on the stock-bond correlation

Abstract

The correlation between stock and bond returns is a cornerstone of asset allocation decisions. History reveals abrupt regime shifts in correlation after long periods of relative stability. We investigate the drivers of the correlation between stocks and bonds and find that inflation, real rates, and government credit worthiness are important explanatory variables. We examine the implications of a shift in the stock-bond correlation and find that increases are associated with higher multi-asset portfolio risk and higher bond risk premia.

Keywords: Bonds, Correlation, Inflation, Interest rates, Stocks

JEL Classification: E30, E40, G10, G11, G12, G15