The Determinants of Stock and Bond Return Comovements
NBER Working Paper No. 15260
We study the economic sources of stock-bond return comovements and its time variation using a dynamic factor model. We identify the economic factors employing a semi-structural regime-switching model for state variables such as interest rates, inflation, the output gap, and cash flow growth. We also view risk aversion, uncertainty about inflation and output, and liquidity proxies as additional potential factors. We find that macro-economic fundamentals contribute little to explaining stock and bond return correlations, but that other factors, especially liquidity proxies, play a more important role. The macro factors are still important in fitting bond return volatility; whereas the "variance premium" is critical in explaining stock return volatility. However, the factor model primarily fails in fitting covariances.
Published: Lieven Baele, 2010. "The Determinants of Stock and Bond Return Comovements," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 23(6), pages 2374-2428, June.