The Stock-Bond Return Relation, the Term Structure’s Slope, and Asset-Class Risk Dynamics

Naresh Bansal, Robert Connolly and Chris Stivers

Journal of Financial and Quantitative Analysis, 2014, vol. 49, issue 3, 699-724

Abstract: We study whether asset-class risk dynamics can help explain the predominantly negative stock-bond return relation and movements in the term structure’s slope over 1997–2011. Using option-derived implied volatilities to measure risk, we find i) the negative stock-bond return relation largely disappears when controlling for risk movements, at both monthly and weekly horizons; ii) the partial relation between equity-risk changes and 10-year T-bond excess returns (term-slope movements) is reliably positive (negative); and iii) a stronger link between equity risk and stock returns implies a more negative stock-bond return correlation. Our results suggest a flight-to-quality influence between equity-risk dynamics and longer-term Treasury pricing.

Date: 2014
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