Inflation expectations and the stock-bond nexus in the US: hedging implications

Abstract

This paper first examines the impact of inflation expectations on the correlation and tail-dependence between stock and Treasury (corporate) bond markets in the US and then assesses the portfolio and hedging implications. Using dynamic C-vine copula models, the results show in several cases a shift in the stock-bond nexus after conditioning on the levels of inflation expectations. The average dynamic tail-dependence between stocks and 10- and 30-year Treasury bonds becomes positive in the post-Covid era. High inflation expectations intensify the average tail-dependence between stocks and mid-term corporate bonds since the Covid-19 outbreak, and between stock and Treasury bonds from early 2020 to the beginning of the conflict between Russia and Ukraine. A hedging analysis shows that the hedging effectiveness improves after taking into account the impact of inflation expectations on stock-bond nexus, especially in the post-Covid-19 subperiod. This hedging effectiveness sustains after changing the proxy of inflation expectations.