Understanding Asset Correlations

Henrik Hasseltoft and Dominic Burkhardt
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Henrik Hasseltoft: Lynx Asset Management; Stockholm School of Economics
Dominic Burkhardt: University of Zurich and Swiss Finance Institute

No 12-38, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: We document an inverse relation between stock-bond correlations and correlations of growth and inflation. We find that rising inflation uncertainty lowers stock prices but can either lower or raise nominal bond prices depending on whether inflation is counter- or procyclical. We show that the time-varying comovement of growth and inflation has important implications for how inflation impacts asset prices. We explain our findings in a long-run risk model with non-neutral inflation shocks and regime shifts, allowing for countercyclical and procyclical inflation regimes. The model can produce an upward-sloping real yield curve and rationally explains the so-called Fed-model. Finally, inflation and monetary policy shocks were important drivers of stock-bond correlations during the countercyclical period 1965-2000 while output shocks dominated during the procyclical period 2000-2011.

Keywords: cyclicality; fed-model; inflation; long-run risks; money illusion; regime-switching; stock-bond correlation (search for similar items in EconPapers)
JEL-codes: E43 E44 G12 (search for similar items in EconPapers)
Pages: 64 pages
Date: 2012-12
New Economics Papers: this item is included in nep-mac
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Citations: View citations in EconPapers (27)

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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp1238

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