Working Paper: NBER ID: w15260
Authors: Lieven Baele; Geert Bekaert; Koen Inghelbrecht
Abstract: 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.
Keywords: Stock returns; Bond returns; Liquidity; Risk aversion; Dynamic factor model
JEL Codes: E43; E44; G11; G12; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| macroeconomic fundamentals (E66) | stock and bond return correlations (G12) |
| liquidity proxies (E41) | stock and bond return correlations (G12) |
| macro factors (E66) | bond return volatility (G12) |
| variance premium (C29) | stock return volatility (G17) |
| joint exposure to economic factors (F69) | comovement between stock and bond returns (G10) |
| volatility of fundamentals (G17) | comovement patterns (C10) |
| opposite exposures of factors (C39) | negative correlations between bonds and stocks (G12) |
| flight-to-safety effects (E44) | negative correlations in stock and bond returns post-2000 (G12) |