Is the effectiveness of government bonds as a diversifier of equity risk weakened after the Covid-19 crisis?†

Abstract

In this paper, we examine how the relationship between the US stock index and the US Treasury market has changed after the start of the Covid-19 crisis. For that purpose, we compute upside and downside correlations between the index and interest rates of different maturities. Our main findings are as follows: first, we document the correlation asymmetry. The downside correlation is higher than the upside correlation before the crisis but the opposite is true after the start of the crisis for all maturities. The magnitude of the change is large for short-term maturities but small for long-term maturities. It indicates that the benefit of holding the short-term government bonds as a diversifier for stock investors is weakened after the start of the Covid-19 crisis. We also study the economic impact of ignoring the correlation asymmetry and report that the cost increased after the start of the crisis in general.