Stocks and Bonds: Flight-to-Safety for Ever?

This paper gives new insights about flight-to-safety from stocks to bonds, asking whether the strength of this phenomenon remains the same in the current environment of low yields. The motivations lie in the conjecture that when yields are low, the traditional motives of flight-to-safety (wealth protection, liquidity) could not be sufficient, inducing weaker flight-to-safety events. Empirical applications using data for U.S. government bonds and the S&P 500 index, show indeed that when yields are low, the strength of flight-to-safety from stocks to bonds weakens. This result holds, even when controlling for the effects of traditional flight-to-safety factors including the VIX, the TED spreads and the overall level of illiquidity in the stock market. Moreover, we develop a bivariate model of flight-to-safety transfers that measures to what extent the strength of flight-to-safety from stocks to bonds is related to the strength of flight-to-safety from stocks to other safe haven assets (gold and currencies). Results show that when the strength of flight-to-safety from stocks to bonds decreases the strength of flight-to-safety from stocks to these safe haven assets increases. This result holds only in the low-yield environment, suggesting a kind of substitution effect of save haven assets, similar to the reaching for yield behavior.