We examine whether time variation in the comovements of daily stock and Treasury bond returns can be linked to measures of stock market uncertainty, specifically the implied volatility from equity index options and detrended stock turnover. From a forward-looking perspective, we find a negative relation between the uncertainty measures and the future correlation of stock and bond returns. Contemporaneously, we find that bond returns tend to be high (low) relative to stock returns during days when implied volatility increases (decreases) substantially and during days when stock turnover is unexpectedly high (low). Our findings suggest that stock market uncertainty has important cross-market pricing in-fluences and that stock-bond diversification benefits increase with stock market uncertainty.

/pdf/stock-market-uncertainty-and-the-stock-bond-return-relation-57k6gggy0z.pdf

Stock Market Uncertainty and the Stock-Bond Return Relation

The covariance between US Treasury bond returns and stock returns has moved considerably over time. While it was slightly positive on average in the period 1953 to 2014, it was unusually high in the early 1980s and negative in the early 21st Century, particularly in the downturns of 2001 and 2007 to 2009. This paper specifies and estimates a model in which the nominal term structure of interest rates is driven by four state variables: the real interest rate, temporary and permanent components of expected inflation, and the nominalreal covariance of inflation and the real interest rate with the real economy. The last of these state variables enables the model to fit the changing covariance of bond and stock returns. In the model, a high nominal-real covariance implies a high term premium and a concave yield curve. The decline in this covariance since the early 1980s has driven down our model-implied term premium on 10-year zero-coupon nominal Treasury bonds by about two percentage points.

/pdf/inflation-bets-or-deflation-hedges-the-changing-risks-of-4wklx19wce.pdf

Inflation Bets or Deflation Hedges? The Changing Risks of Nominal Bonds

Flights and contagion—An empirical analysis of stock–bond correlations☆

This paper analyzes the existence of flights from stocks to bonds and vice versa. We propose a definition and a test for flight-to-quality, flight-from-quality and cross-asset contagion and examine their characteristics and effects for the financial system. The empirical analysis for eight developed countries including the US, the UK, Germany and Japan shows that flights exist and are a common feature in many crises episodes. Our findings also reveal that flights are not merely country-specific events but occur simultaneously across countries. This indicates that there is a link between the occurrence of flights and cross-country contagion. Moreover, we show that flights enhance the resiliency of the financial markets by providing diversification benefits in times when they are needed most.

https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1259995_code339445.pdf?abstractid=886119&rulid=268637&mirid=2

Flights and Contagion - an Empirical Analysis of Stock-Bond Correlations

This article examines the impact of inflation and economic growth expectations and perceived stock market uncertainty on the time-varying correlation between stock and bond returns. The results indicate that stock and bond prices move in the same direction during periods of high inflation expectations, while epochs of negative stock–bond return correlation seem to coincide with subdued inflation expectations. Furthermore, consistent with the ‘flight-to-quality’ phenomenon, the results suggest that periods of elevated stock market uncertainty lead to a decoupling between stock and bond prices. Finally, it is found that the stock–bond return correlation is virtually unaffected by economic growth expectations.

Why does the correlation between stock and bond returns vary over time

This paper examines the correlation between stock and bond returns. It first documents that the major trends in stock-bond correlation for G7 countries follow a similar reverting pattern in the past forty years. Next, an asset pricing model is employed to show that the correlation of stock and bond returns can be explained by their common exposure to macroeconomic factors. The link between the stock-bond correlation and macroeconomic factors is examined using three successively more realistic formulations of asset return dynamics. Empirical results indicate that the major trends in stock-bond correlation are determined primarily by uncertainty about expected inflation. Unexpected inflation and the real interest rate are significant to a lesser degree. Forecasting this stock-bond correlation using macroeconomic factors also helps improve investors' asset allocation decisions. One implication of this link between trends in stock-bond correlation and inflation risk is the Murphy's Law of Diversification: Diversification opportunities are least available when they are most needed.

/pdf/macroeconomic-factors-and-the-correlation-of-stock-and-bond-2883a06kd8.pdf

Macroeconomic Factors and the Correlation of Stock and Bond Returns

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Macroeconomic Factors and the Correlation of Stock and Bond Returns

Macroeconomic Factors and the Correlation of Stock and Bond Returns