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The effect of economic policy uncertainty on the long-term correlation between U.S. stock and bond markets

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  • Fang, Libing
  • Yu, Honghai
  • Li, Lei

Abstract

We investigate the time-varying long-term correlation of U.S. stock and bond markets, as influenced by an economic policy uncertainty (EPU) index based on the modified DCC-MIDAS model. Considering the structural breakpoints of the 1997 Asian financial crisis and the 2008 financial crisis, we extend the model by incorporating dummy variables to adjust the long-term correlation during different periods. The empirical results show that the modified model is more efficient than the baseline model. Moreover, consistent with the flight-to-quality phenomenon, we further find that EPU has a significant negative influence on long-term stock-bond correlation.

Suggested Citation

  • Fang, Libing & Yu, Honghai & Li, Lei, 2017. "The effect of economic policy uncertainty on the long-term correlation between U.S. stock and bond markets," Economic Modelling, Elsevier, vol. 66(C), pages 139-145.
    • Handle: RePEc:eee:ecmode:v:66:y:2017:i:c:p:139-145
    DOI: 10.1016/j.econmod.2017.06.007
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    More about this item

    Keywords

    E60; G10; C32; C52; DCC-MIDAS model; Structural break; Economic policy uncertainty; Long-term correlation;
    All these keywords.

    JEL classification:

    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection

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