IDEAS home Printed from https://ideas.repec.org/p/pra/mprapa/75871.html
   My bibliography  Save this paper

The Stock-Bond Comovements and Cross-Market Trading

Author

Listed:
  • Li, Mengling
  • Zheng, Huanhuan
  • Chong, Terence Tai Leung
  • Zhang, Yang

Abstract

We propose an asset pricing model with heterogeneous agents allocating capital to the stock and bond markets to optimize their portfolios, utilizing the dynamic interaction between the two markets. While some agents focus on the stock market and have more expertise in it, the others specialize in the bond market. Based on their comparative advantages in a particular market, heterogeneous agents constantly revise their investment portfolios by taking into account the time-varying stock-bond return comovements and the changing market conditions. Agents’ collective investment behavior shapes the stock-bond interlinkage, which feedbacks on their subsequent capital allocations. Using monthly US stock and bond data from January 1990 to June 2014, we estimate the vector autoregression model with threshold and Markov switching mechanisms. We find evidence in support of flight-to-quality and show that it is mainly driven by the technical traders who actively sell stocks and buy bonds during periods of high market uncertainty.

Suggested Citation

  • Li, Mengling & Zheng, Huanhuan & Chong, Terence Tai Leung & Zhang, Yang, 2016. "The Stock-Bond Comovements and Cross-Market Trading," MPRA Paper 75871, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:75871
    as

    Download full text from publisher

    File URL: https://mpra.ub.uni-muenchen.de/75871/1/MPRA_paper_75871.pdf
    File Function: original version
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Schmitt, Noemi & Westerhoff, Frank, 2014. "Speculative behavior and the dynamics of interacting stock markets," Journal of Economic Dynamics and Control, Elsevier, vol. 45(C), pages 262-288.
    2. Weihong Huang & Huanhuan Zheng & Wai-Mun Chia, 2013. "Asymmetric returns, gradual bubbles and sudden crashes," The European Journal of Finance, Taylor & Francis Journals, vol. 19(5), pages 420-437, May.
    3. Stephen A. Ross, 2005. "Mutual Fund Separation in Financial Theory—The Separating Distributions," World Scientific Book Chapters, in: Sudipto Bhattacharya & George M Constantinides (ed.), Theory Of Valuation, chapter 10, pages 309-356, World Scientific Publishing Co. Pte. Ltd..
    4. Shiller, Robert J. & Beltratti, Andrea E., 1992. "Stock prices and bond yields : Can their comovements be explained in terms of present value models?," Journal of Monetary Economics, Elsevier, vol. 30(1), pages 25-46, October.
    5. Fleming, Jeff & Kirby, Chris & Ostdiek, Barbara, 1998. "Information and volatility linkages in the stock, bond, and money markets," Journal of Financial Economics, Elsevier, vol. 49(1), pages 111-137, July.
    6. Connolly, Robert & Stivers, Chris & Sun, Licheng, 2005. "Stock Market Uncertainty and the Stock-Bond Return Relation," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 40(1), pages 161-194, March.
    7. Roberto Dieci & Xue-Zhong He & Cars Hommes (ed.), 2014. "Nonlinear Economic Dynamics and Financial Modelling," Springer Books, Springer, edition 127, number 978-3-319-07470-2, November.
    8. Frijns, Bart & Lehnert, Thorsten & Zwinkels, Remco C.J., 2010. "Behavioral heterogeneity in the option market," Journal of Economic Dynamics and Control, Elsevier, vol. 34(11), pages 2273-2287, November.
    9. d'Addona, Stefano & Kind, Axel H., 2006. "International stock-bond correlations in a simple affine asset pricing model," Journal of Banking & Finance, Elsevier, vol. 30(10), pages 2747-2765, October.
    10. Boswijk, H. Peter & Hommes, Cars H. & Manzan, Sebastiano, 2007. "Behavioral heterogeneity in stock prices," Journal of Economic Dynamics and Control, Elsevier, vol. 31(6), pages 1938-1970, June.
    11. Eugene F. Fama & Kenneth R. French, 2002. "The Equity Premium," Journal of Finance, American Finance Association, vol. 57(2), pages 637-659, April.
    12. de Jong, Eelke & Verschoor, Willem F.C. & Zwinkels, Remco C.J., 2009. "Behavioural heterogeneity and shift-contagion: Evidence from the Asian crisis," Journal of Economic Dynamics and Control, Elsevier, vol. 33(11), pages 1929-1944, November.
    13. Hamilton, James D., 1990. "Analysis of time series subject to changes in regime," Journal of Econometrics, Elsevier, vol. 45(1-2), pages 39-70.
    14. Andersen, Torben G. & Bollerslev, Tim & Diebold, Francis X. & Vega, Clara, 2007. "Real-time price discovery in global stock, bond and foreign exchange markets," Journal of International Economics, Elsevier, vol. 73(2), pages 251-277, November.
    15. Chiarella, Carl & He, Xue-Zhong & Huang, Weihong & Zheng, Huanhuan, 2012. "Estimating behavioural heterogeneity under regime switching," Journal of Economic Behavior & Organization, Elsevier, vol. 83(3), pages 446-460.
    16. Campbell, John Y & Ammer, John, 1993. "What Moves the Stock and Bond Markets? A Variance Decomposition for Long-Term Asset Returns," Journal of Finance, American Finance Association, vol. 48(1), pages 3-37, March.
    17. Matthijs Lof, 2015. "Rational Speculators, Contrarians, and Excess Volatility," Management Science, INFORMS, vol. 61(8), pages 1889-1901, August.
    18. Westerhoff, Frank & Reitz, Stefan, 2005. "Commodity price dynamics and the nonlinear market impact of technical traders: empirical evidence for the US corn market," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 349(3), pages 641-648.
    19. Ehrmann, Michael & Ellison, Martin & Valla, Natacha, 2003. "Regime-dependent impulse response functions in a Markov-switching vector autoregression model," Economics Letters, Elsevier, vol. 78(3), pages 295-299, March.
    20. Lieven Baele, 2010. "The Determinants of Stock and Bond Return Comovements," The Review of Financial Studies, Society for Financial Studies, vol. 23(6), pages 2374-2428, June.
    21. Menkhoff, Lukas & Rebitzky, Rafael R. & Schröder, Michael, 2009. "Heterogeneity in exchange rate expectations: Evidence on the chartist-fundamentalist approach," Journal of Economic Behavior & Organization, Elsevier, vol. 70(1-2), pages 241-252, May.
    22. Barsky, Robert B, 1989. "Why Don't the Prices of Stocks and Bonds Move Together?," American Economic Review, American Economic Association, vol. 79(5), pages 1132-1145, December.
    23. Franke, Reiner & Westerhoff, Frank, 2012. "Structural stochastic volatility in asset pricing dynamics: Estimation and model contest," Journal of Economic Dynamics and Control, Elsevier, vol. 36(8), pages 1193-1211.
    24. Nathan S. Balke, 2000. "Credit and Economic Activity: Credit Regimes and Nonlinear Propagation of Shocks," The Review of Economics and Statistics, MIT Press, vol. 82(2), pages 344-349, May.
    25. Yang, Jian & Zhou, Yinggang & Wang, Zijun, 2009. "The stock-bond correlation and macroeconomic conditions: One and a half centuries of evidence," Journal of Banking & Finance, Elsevier, vol. 33(4), pages 670-680, April.
    26. Tarun Chordia, 2005. "An Empirical Analysis of Stock and Bond Market Liquidity," Review of Financial Studies, Society for Financial Studies, vol. 18(1), pages 85-129.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Perras, Patrizia & Wagner, Niklas, 2020. "Pricing equity-bond covariance risk: Between flight-to-quality and fear-of-missing-out," Journal of Economic Dynamics and Control, Elsevier, vol. 121(C).
    2. Chen, Na & Jin, Xiu, 2020. "Industry risk transmission channels and the spillover effects of specific determinants in China’s stock market: A spatial econometrics approach," The North American Journal of Economics and Finance, Elsevier, vol. 52(C).
    3. Cheng, Sheng & Cao, Yan, 2019. "On the relation between global food and crude oil prices: An empirical investigation in a nonlinear framework," Energy Economics, Elsevier, vol. 81(C), pages 422-432.
    4. Hussain Shahzad, Syed Jawad & Raza, Naveed & Shahbaz, Muhammad & Ali, Azwadi, 2017. "Dependence of stock markets with gold and bonds under bullish and bearish market states," Resources Policy, Elsevier, vol. 52(C), pages 308-319.
    5. Frijns, Bart & Zwinkels, Remco C.J., 2018. "Time-varying arbitrage and dynamic price discovery," Journal of Economic Dynamics and Control, Elsevier, vol. 91(C), pages 485-502.
    6. Chen, Na & Jin, Xiu, 2023. "Cross-industry asset allocation with the spatial interaction on multiple risk transmission channels," The North American Journal of Economics and Finance, Elsevier, vol. 67(C).
    7. Ji, Jingru & Wang, Donghua & Xu, Dinghai, 2019. "Modelling the spreading process of extreme risks via a simple agent-based model: Evidence from the China stock market," Economic Modelling, Elsevier, vol. 80(C), pages 383-391.
    8. Deng, Chao & Su, Xiaojian & Wang, Gangjin & Peng, Cheng, 2022. "The existence of flight-to-quality under extreme conditions: Evidence from a nonlinear perspective in Chinese stocks and bonds' sectors," Economic Modelling, Elsevier, vol. 113(C).
    9. Mengling Li & Huanhuan Zheng, 2017. "Heterogeneous trading and complex price dynamics," Journal of Economic Interaction and Coordination, Springer;Society for Economic Science with Heterogeneous Interacting Agents, vol. 12(2), pages 437-442, July.
    10. Wang, Hong-Yong & Wang, Tong-Tong, 2018. "Multifractal analysis of the Chinese stock, bond and fund markets," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 512(C), pages 280-292.
    11. Wang, Luxia & Chong, Terence Tai Leung & He, Yiyao & Liu, Yuchen, 2018. "The Underpricing of Venture Capital Backed IPOs in China," MPRA Paper 92079, University Library of Munich, Germany.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Skintzi, Vasiliki D., 2019. "Determinants of stock-bond market comovement in the Eurozone under model uncertainty," International Review of Financial Analysis, Elsevier, vol. 61(C), pages 20-28.
    2. Zhenxi Chen & Weihong Huang & Huanhuan Zheng, 2018. "Estimating heterogeneous agents behavior in a two-market financial system," Journal of Economic Interaction and Coordination, Springer;Society for Economic Science with Heterogeneous Interacting Agents, vol. 13(3), pages 491-510, October.
    3. Wai-Mun Chia & Mengling Li & Huanhuan Zheng, 2017. "Behavioral heterogeneity in the Australian housing market," Applied Economics, Taylor & Francis Journals, vol. 49(9), pages 872-885, February.
    4. Ermolov, Andrey, 2022. "Time-varying risk of nominal bonds: How important are macroeconomic shocks?," Journal of Financial Economics, Elsevier, vol. 145(1), pages 1-28.
    5. Demirovic, Amer & Guermat, Cherif & Tucker, Jon, 2017. "The relationship between equity and bond returns: An empirical investigation," Journal of Financial Markets, Elsevier, vol. 35(C), pages 47-64.
    6. Goyenko, Ruslan & Sarkissian, Sergei, 2010. "Flight to Liquidity and Global Equity Returns," MPRA Paper 27546, University Library of Munich, Germany.
    7. Gupta, Rangan & Kollias, Christos & Papadamou, Stephanos & Wohar, Mark E., 2018. "News implied volatility and the stock-bond nexus: Evidence from historical data for the USA and the UK markets," Journal of Multinational Financial Management, Elsevier, vol. 47, pages 76-90.
    8. Saskia ter Ellen & Willem F.C. Verschoor, 2017. "Heterogeneous beliefs and asset price dynamics: a survey of recent evidence," Working Paper 2017/22, Norges Bank.
    9. Zhong-Qiang Zhou & Jie Li & Wei Zhang & Xiong Xiong, 2022. "Government intervention model based on behavioral heterogeneity for China’s stock market," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 8(1), pages 1-19, December.
    10. Campbell, John Y. & Sunderam, Adi & Viceira, Luis M., 2017. "Inflation Bets or Deflation Hedges? The Changing Risks of Nominal Bonds," Critical Finance Review, now publishers, vol. 6(2), pages 263-301, September.
    11. Underwood, Shane, 2009. "The cross-market information content of stock and bond order flow," Journal of Financial Markets, Elsevier, vol. 12(2), pages 268-289, May.
    12. Kukacka, Jiri & Barunik, Jozef, 2017. "Estimation of financial agent-based models with simulated maximum likelihood," Journal of Economic Dynamics and Control, Elsevier, vol. 85(C), pages 21-45.
    13. Mengling Li & Huanhuan Zheng, 2017. "Heterogeneous trading and complex price dynamics," Journal of Economic Interaction and Coordination, Springer;Society for Economic Science with Heterogeneous Interacting Agents, vol. 12(2), pages 437-442, July.
    14. Ivan Indriawan & Feng Jiao & Yiuman Tse, 2019. "The impact of the US stock market opening on price discovery of government bond futures," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 39(7), pages 779-802, July.
    15. Chiarella, Carl & He, Xue-Zhong & Huang, Weihong & Zheng, Huanhuan, 2012. "Estimating behavioural heterogeneity under regime switching," Journal of Economic Behavior & Organization, Elsevier, vol. 83(3), pages 446-460.
    16. Christian Leschinski & Michelle Voges & Philipp Sibbertsen, 2021. "Integration and Disintegration of EMU Government Bond Markets," Econometrics, MDPI, vol. 9(1), pages 1-17, March.
    17. Refk Selmi & Christos Kollias & Stephanos Papadamou & Rangan Gupta, 2017. "A Copula-Based Quantile-on-Quantile Regression Approach to Modeling Dependence Structure between Stock and Bond Returns: Evidence from Historical Data of India, South Africa, UK and US," Working Papers 201747, University of Pretoria, Department of Economics.
    18. Mihaela NICOLAU, 2010. "Financial Markets Interactions between Economic Theory and Practice," Economics and Applied Informatics, "Dunarea de Jos" University of Galati, Faculty of Economics and Business Administration, issue 2, pages 27-36.
    19. Kontonikas, Alexandros & MacDonald, Ronald & Saggu, Aman, 2013. "Stock market reaction to fed funds rate surprises: State dependence and the financial crisis," Journal of Banking & Finance, Elsevier, vol. 37(11), pages 4025-4037.
    20. Chen, Zhenxi, 2014. "Estimating heterogeneous agents behavior with different investment horizons in stock markets," FinMaP-Working Papers 5, Collaborative EU Project FinMaP - Financial Distortions and Macroeconomic Performance: Expectations, Constraints and Interaction of Agents.

    More about this item

    Keywords

    Heterogeneity; Stock-Bond Comovement; Markov Switching VAR; Threshold VAR.;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:pra:mprapa:75871. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Joachim Winter (email available below). General contact details of provider: https://edirc.repec.org/data/vfmunde.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.