Article | Review of Asset Pricing Studies | June 2012

Comovement and Predictability Relationships Between Bonds and the Cross-Section of Stocks

by Malcolm Baker and Jeffrey Wurgler


Government bonds comove more strongly with bond-like stocks: stocks of large, mature, low-volatility, profitable, dividend-paying firms that are neither high growth nor distressed. Variables derived from the yield curve that are already known to predict returns on bonds also predict returns on bond-like stocks; investor sentiment, a predictor of the cross section of stock returns, also predicts excess bond returns. These relationships remain in place even when bonds and stocks become "decoupled" at the index level. They are driven by a combination of effects including correlations between real cash flows on bonds and bond-like stocks, correlations between their risk-based return premia, and periodic flights to quality.

Keywords: Relationships; Bonds; Stocks; Investment Return; Cash Flow; Quality; Risk and Uncertainty; Forecasting and Prediction; Profit;