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Equity/bond yield correlation and the FED model: evidence of switching behaviour from the G7 markets

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  • Andreas Humpe

    (Hochschule für angewandte Wissenschaften München)

  • David G. McMillan

    (University of Stirling)

Abstract

This paper considers how the strength and nature of the relation between the equity and bond yield varies with the level of the real bond yield. We demonstrate that at low levels of the real bond yield, the correlation between the equity and bond yields turns negative. This arises as the lower bond yield implies heightened macroeconomic risk (e.g. deflation and economic stagnation) and causes equity and bond prices to move in opposite directions. The FED model relies on a positive relation for its success in predicting future returns. Thus, we argue that the mixed empirical evidence regarding the FED model arises due to this switch in correlation behaviour. We present supportive evidence for the switching relation and its link to the level of the bond yield using linear and nonlinear smooth transition panel regression techniques for the G7 markets. The results presented here should be of interest to market practitioners who may wish to use the FED model to aid market timing decisions and for academics interested in understanding the interrelations between markets.

Suggested Citation

  • Andreas Humpe & David G. McMillan, 2018. "Equity/bond yield correlation and the FED model: evidence of switching behaviour from the G7 markets," Journal of Asset Management, Palgrave Macmillan, vol. 19(6), pages 413-428, October.
    • Handle: RePEc:pal:assmgt:v:19:y:2018:i:6:d:10.1057_s41260-018-0091-x
    DOI: 10.1057/s41260-018-0091-x
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    2. Piñeiro-Chousa, Juan & López-Cabarcos, M. Ángeles & Šević, Aleksandar, 2022. "Green bond market and Sentiment: Is there a switching Behaviour?," Journal of Business Research, Elsevier, vol. 141(C), pages 520-527.

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    More about this item

    Keywords

    Equity returns; Bond returns; Correlation; Bond yield; Switching;
    All these keywords.

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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