The Relation Between Fixed Income and Equity Return Factors

Jaime Lee, Terry Marsha, Robert Maxim and Paul Pfleiderer

Volume 4, Number 4, Fourth Quarter 2006

This paper provides an analysis of the relation between equity and fixed income returns over time. As measured by realized correlation, this relation has changed substantially over the last decade, from positive to negative through the market collapse and is currently around zero. We find “jumps” in the co-movements of equity and bond returns at a daily frequency; these jumps can at times be attributed to “flight to liquidity” phenomena in the markets, and at other times, to apparent surprise announcements in expected inflation or related macro conditions. We find no evidence of short-run persistence in the jumps in daily co-movement of bond and equity returns, but there does seem to be a “regime-like” longer-run persistence in them, perhaps associated with Federal Reserve “management over the last decade.