Interrelation and Spillover Effects between Stocks and Bonds: Cross-Market and Cross-Asset Evidence

Abstract

Purpose: This paper examines the behaviour, both contemporaneous and causal, of stock and bond markets across four major international countries. Design/Methodology/Approach: We generate volatility and correlations using the realised volatility approach and implement a general VAR approach to examine causality and spillovers. Findings: While results confirm that same asset-cross country return correlations and spillovers increase over time, the same in not true with variance and covariance behaviour. Volatility spillovers across countries exhibit a substantial amount of time-variation, however, there is no evidence of trending in any direction. Equally, cross asset-same country correlations exhibit both negative and positive values. Further, we report an inverse relation between same asset-cross country return correlations and cross asset-same country return correlations i.e., the stock return correlation across countries increases at the same time the stock and bond return correlation within each country declines. Moreover, results show that the stock and bond return correlations exhibit commonality across countries. Results also demonstrate that stock returns lead movement in bond returns, while US stock and bond returns have predictive power other country stock and bond returns. In terms of the markets analysed, Japan exhibit a distinct nature compared with those of Germany, the UK and the US. Originality The results presented here provide a detailed characterisation of how assets interact both with each other and cross countries and should be of interest to portfolio managers, policy-makers and those interested in modelling cross market behaviour. Notably, we reveal key differences between the behaviour of stocks and bonds and across different countries.