Equity-Bond Returns Correlation and the Bond Yield: Evidence of Switching Behaviour from the G7 Markets

This paper examines the nature of the correlation between (real) equity and bond returns for the G7 markets. From the standpoint of established finance theory, we would expect a positive returns correlation, however, evidence has been presented to suggest that a negative correlation occurs over certain time periods. Using both panel and individual regression for the G7 markets we demonstrate that the correlation is itself positively correlated with the (real) bond yield. While a higher (lower) bond yield is generally associated with both falling (rising) equity and bond prices, a low and falling yield can cause bond prices to rise but equity prices to fall as it implies macroeconomic risk from potential deflation and economic stagnation. Furthermore, our results suggest that a real bond yield of less than 3 % is associated with a negative returns correlation. From an investor view point this suggests the potential for beneficial diversification, while also having implications for asset valuation.