The Stock-Bond Correlation and Macroeconomic Conditions: One and a Half Centuries of Evidence

Abstract

Using monthly stock and bond return data in the past 150 years (1855-2001) for both the U.S. and the U.K., this study documents time-varying stock-bond correlation over macroeconomic conditions (the business cycle, the inflation environment and monetary policy stance). There are different patterns of time variation in stock-bond correlations over the business cycle between U.S. and U.K., which implies that bonds may be a better hedge against stock market risk and offer more diversification benefits to stock investors in the US than in the UK. Further, there is a general pattern across both the U.S. and the U.K. during the post-1923 subperiod and during the whole sample period: higher stock-bond correlations tend to follow higher short rates and (to a lesser extent) higher inflation rates.

Keywords: Stock-bond correlation, Business cycle, Asymmetry, Smooth transition, GARCH

JEL Classification: G12, G15, E44