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Stock-bond co-movements and cross-country linkages

Dirk G. Baur
IIIS Discussion Paper No. 216

This paper shows empirically that the level of stock-bond correlation depends more on crosscountry influences than on stock and bond market interaction. The study examines the relation of cross-country and cross-asset stock and bond market linkages for eight developed countries and finds that (i) stock market returns primarily depend on the US stock market and (ii) bond market returns primarily depend on the US bond market. Recursive Granger causality tests further show that the dominance of the US stock and bond market has increased in recent years and that there is both Granger causality from stocks to bonds and from bonds to stocks in several periods. We argue that the relatively low level of stock-bond correlations is due to an increased cross-country interdependence of financial markets leading to more frequent portfolio reallocations between stocks and bonds in order to compensate for lower cross-country diversification benefits.

JEL classification: C32; E44; F3; G14; G15

Keywords: financial market integration, stock market co-movements, bond market co-movements, stock-bond linkages, flight-to-quality, contagion

Last updated 28 August 2014 by IIIS (Email).