Stock-Bond Return Correlation: Understanding the Changing Behaviour

Citation

McMillan D (2026) Stock-Bond Return Correlation: Understanding the Changing Behaviour. Journal of International Financial Markets, Institutions and Money, 106, Art. No.: 102242. https://doi.org/10.1016/j.intfin.2025.102242

Abstract
The stock and bond return correlation remains important given its central role in portfolio behaviour. Previous, primarily US, evidence indicates sign switching, which implies that bonds change between diversifying and hedging behaviour. This paper considers time-variation in the stock-bond correlation for the G7 markets, including the nature of its economic drivers. Using monthly data over a period spanning 1980 to 2023 evidence demonstrates that the correlation switches from positive to negative in the late 1990s for six of the seven markets (the switch for Japan occurs in the first half of the 1990s). A switch back to positive is observed towards the end of the sample for most markets but earlier for France and Italy. Evidence of time-variation within the correlation drivers is also noted. Nonetheless, results suggest that inflation and interest rates typically exhibit a positive effect on the correlation, consistent with previous work and theoretical underpinnings. That is, higher inflation and interest rates depress stock and bond prices due to higher discount rates and lower real cash flows, moving them in the same direction. Growth also largely imparts a positive effect on the correlation, but this contrasts with the prevailing view. This arises through portfolio considerations where higher growth leads to an increase in demand for all assets. Of importance for investors, the switch in correlation implies that a portfolio manager will need to alter asset weights to maintain a target value for returns or risk. A portfolio variance decomposition reveals that while the bond contribution remains broadly constant over the sample, that from stocks increases as the correlation contribution shifts from positive to negative. The results are of importance to investors and those engaged in modelling market behaviour.

Keywords
Stock returns; Bond returns; Time-varying correlation; Growth; Inflation; Real interest rates; Breakpoint regression

• Stock-Bond Return Correlation: Understanding the Changing Behaviour