On risk factors of the stock–bond correlation

Marcello Pericoli

International Finance, 2020, vol. 23, issue 3, 392-416

Abstract: The correlation between stock and bond returns, which went from positive in the 1980–1990s to negative in the 2000–2010s, is analysed with a model that simultaneously determines the price of stocks and bonds as dependent on the real interest rate, economic growth and inflation. The analysis finds that the structural reversal of the correlation in the United States and Germany largely depends on the dynamics of inflation, which has gone from counter‐cyclical to pro‐cyclical. In turn, inflation is likely to be pro‐cyclical when it is low or negative and propelled by demand rather than supply shocks. A negative correlation implies that bonds can hedge the risk of stocks when the economy is in poor condition, thus increasing the demand for bonds. However, central‐bank purchases of long‐term bonds have increased the correlation and made portfolio immunization more difficult for investors.

Date: 2020
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https://doi.org/10.1111/infi.12369

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Persistent link: https://EconPapers.repec.org/RePEc:bla:intfin:v:23:y:2020:i:3:p:392-416

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