The Price of Bond Market-Stock Market Correlation Risk

29 Pages Posted: 24 Mar 2005

See all articles by C. N. V. Krishnan

C. N. V. Krishnan

Case Western Reserve University - Department of Banking & Finance

Ralitsa Petkova

Case Western Reserve University - Department of Banking & Finance

Peter H. Ritchken

Case Western Reserve University - Department of Banking & Finance

Date Written: March 2005

Abstract

Bonds are attractive investment instruments that complement a broad-based equity portfolio. As the correlation between stocks and bonds increases, investors lose diversification benefits. Stocks that pay out more in states in which the aggregate stock-bond correlation is high will be deemed more attractive and their expected returns should be lower. Our hypothesis is then that the stock market-bond market correlation is a risk factor. To test this, we extract the riskless bond-stock market correlation using several different methods that include the BEKK and the Dynamic Conditional Correlation methods. We examine the price of bond-stock correlation risk in the cross section of stock returns. We find that aggregate correlation carries a statistically significant negative price of risk of about 3 percent that cannot be explained by the market return, size, book-to-market, default spread, term spread, unexpected inflation and other known risk factors.

Keywords: Bond Market-Stock Market Correlation, Price of Correlation Risk

Suggested Citation

Krishnan, C. N. V. and Petkova, Ralitsa and Ritchken, Peter H., The Price of Bond Market-Stock Market Correlation Risk (March 2005). Available at SSRN: https://ssrn.com/abstract=687285 or http://dx.doi.org/10.2139/ssrn.687285

C. N. V. Krishnan (Contact Author)

Case Western Reserve University - Department of Banking & Finance ( email )

11119 Bellflower Rd
PBL 363
Cleveland, OH 44106-7235
United States
216-368-2116 (Phone)

HOME PAGE: http://weatherhead.case.edu/faculty/c-n-v-krishnan

Ralitsa Petkova

Case Western Reserve University - Department of Banking & Finance ( email )

10900 Euclid Ave.
Cleveland, OH 44106-7235
United States

Peter H. Ritchken

Case Western Reserve University - Department of Banking & Finance ( email )

10900 Euclid Ave.
Cleveland, OH 44106-7235
United States
216-368-3849 (Phone)
216-368-4776 (Fax)

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