Abstract
This paper investigates dynamic correlations of stock–bond returns for different stock indices and bond maturities. Evidence in the US shows that stock–bond relations are time-varying and display a negative trend. The stock–bond correlations are negatively correlated with implied volatilities in stock and bond markets. Tests show that stock–bond relations are positively correlated with economic policy uncertainty, however, are negatively correlated with the monetary policy and fiscal policy uncertainties. Correlation coefficients between stock and bond returns are positively related to total policy uncertainty for returns of the Dow-Jones Industrial Average (DJIA) and the S&P 500 Value stock index (VALUE), but negatively correlated with returns of S&P500 (Total market), the NASDAQ Composite Index (NASDAQ), and the RUSSELL 2000 (RUSSELL).
Highlights
The investigation on correlations of stock and bond returns has long been a key concern of portfolio managers and financial market strategists (Connolly et al 2005; Panchenko and Wu 2009; Baur and Lucey 2009; Li et al 2019, among others)
Panel C provides a correlation matrix that illustrates the correlation of VIX and different categorical policy uncertainties. It shows that fiscal policy uncertainty (FPU) and monetary policy uncertainty (MPU) are highly correlated with economic policy uncertainty (EPU), and VIX has the highest correlation with Merrill Lynch Option Volatility Estimate (MOVE)
This paper examines the impact of financial market risk and policy uncertainties on the correlation between stock and bond returns
Summary
The investigation on correlations of stock and bond returns has long been a key concern of portfolio managers and financial market strategists (Connolly et al 2005; Panchenko and Wu 2009; Baur and Lucey 2009; Li et al 2019, among others) This is because the derived parametric relations could provide useful guidance in portfolio selection, dynamic asset allocation, and risk management. This study focus on broad information in developing measures of financial risks such as VIX, Merrill Lynch Option Volatility Estimate (MOVE) and uncertainty (EMU) to explain the time-varying correlations between stock and bond returns.
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