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Realized Bond-Stock Correlation: Macroeconomic Announcement Effects

How do markets adjust to important news arrivals? How and to what extent are bond and stock markets linked to fundamentals? Do macroeconomic announcement effects vary across assets? Do the price discovery processes in different markets proceed independently or in tandem? Does the current economic business cycle characterize the market’s price reactions to macroeconomic news? In this paper, we attempt to shed new light on these important issues.

This paper studies the news impact of US macroeconomic announcements on realized variance and realized correlation of bond and stock returns. While the previous literature focuses on the price and volatility impact of scheduled macroeconomic news, we investigate the effect on the realized correlation between bond and stock returns. The study of comovement across asset classes is relevant for many reasons. First, asset correlation is a key issue in asset allocation decisions. Portfolio optimization hinges on the concept of correlation. Second, correlation is a central issue in risk management and hedging.

Third, correlation patterns across business cycles and in response to major macroeconomic announcements provide interesting information that help disentangle the factors that dominate the valuation mechanism of stocks and bonds. The evolvement through time and across economic regimes of the sensitivity of asset values to inflation, real interest rates, and other asset-specific factors is informative for monetary policy decision makers and central bankers.

Using trade by trade data, we analyze more than a decade of realized correlation between US government bonds and stocks. This long sample period allows us to address two essential features of bond-stock comovement: its time-varying nature and its state dependent character. Furthermore, we investigate the macroeconomic news impact on realized correlation.

Realized Bond-Stock Correlation: Macroeconomic Announcement Effects