Predicting stock‐bond correlations

Refers to previous research on deciding the balance between equities and bonds in investment portfolios and puts forward a model based on a single period correlation to predict future stock‐bond correlations from past interest and growth rates. Explains the concepts involved and uses 1948‐2000 US data to test it. Shows that the model predicts stock‐bond correlation significantly better than the traditional method of extrapolating from past correlations; and relates this to the theory of loanable funds. Concludes that high interest rates and high growth lead to higher correlations between stocks and bonds and calls for further research.