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How Bad Must Conditions Be To Make Investors Flee?

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  • Dirk G. Baur

Abstract

This paper examines the conditions under which investors flee from stocks to bonds or vice versa. Daily and weekly stock and bond returns are analyzed to determine when investors start to flee from a market and rebalance their portfolios. We use a theoretical model that demonstrates why rational investors deviate from the optimal portfolio weights and under which conditions they rebalance their portfolios. Quantile Regression is employed to analyze empirically when investors flee from certain asset classes. The results demonstrate significant advantages of this approach compared to commonly employed (dynamic) correlation estimates. The approach can quasi-endogenously identify different regimes of stock-bond co-movements and directly distinguish between flight-to-quality and flightfrom-quality. Our empirical results for eight major stock and bond markets show that there are three distinct regimes of stock-bond co-movements. Time-varying quantile estimates further show that there is a positive trend in the likelihood and severity of flights. The findings show that diversification between stocks and bonds is effective especially in times when it is needed most.

Suggested Citation

  • Dirk G. Baur, 2008. "How Bad Must Conditions Be To Make Investors Flee?," The Institute for International Integration Studies Discussion Paper Series iiisdp246, IIIS.
  • Handle: RePEc:iis:dispap:iiisdp246
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    1. Bekaert, Geert & Harvey, Campbell R. & Lumsdaine, Robin L., 2002. "Dating the integration of world equity markets," Journal of Financial Economics, Elsevier, vol. 65(2), pages 203-247, August.
    2. Kee-Hong Bae & G. Andrew Karolyi & René M. Stulz, 2003. "A New Approach to Measuring Financial Contagion," Review of Financial Studies, Society for Financial Studies, vol. 16(3), pages 717-763, July.
    3. Lieven Baele & Annalisa Ferrando & Peter Hördahl & Elizaveta Krylova & Cyril Monnet, 2004. "Measuring financial integration in the euro area," Occasional Paper Series 14, European Central Bank.
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