The Real Channel for Nominal Bond-Stock Puzzles
We present evidence that the nature of aggregate consumption dynamics change around the time the bond-stock correlation switches sign. We identify three regimes in a real-time, sequential learning framework: two highly persistent regimes where either permanent or transitory consumption shocks are relatively more dominant, and a disaster regime that is largely transitory. We study implications of this finding for asset prices. The transition from the second to the first regime in the late 1990s makes the correlation between equities and real bonds switch sign from positive to negative as in the data, thus providing an explanation for this fact from the perspective of real consumption dynamics. The findings extend to the international setting.
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