Macroeconomic determinants of conditional stock-bond correlation

Abstract

This paper analyzes effects of macroeconomic variables on cross- asset market linkages based on the stock-bond returns correlation. The study focuses on the dependence of stock-bond returns correlation on inflation and interest rate, and attempts to explain conditional stock-bond correlation using the argument that these variables’ effects change based on levels of their volatilities as suggested by rational present value asset pricing theory, rather than the characteristics of the distribution of conditional correlations. We propose that variation in the effects of expected level of interest rates and inflation across their volatility levels can explain conditional stock-bond returns correlation. The findings show that inflation expectations and volatilities but not interest rate can explain conditional stock-bond correlations.

Keywords: Conditional stock-bond correlations, macroeconomic variables, inflation, volatilities