The stock–bond comovements and cross-market trading |
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| Institution: | 1. Department of Economics, School of Economics & Wang Yanan Institute of Economics (WISE), Xiamen University, 422 South Siming Road, Xiamen, Fujian, China;2. Department of Economics and Lau Chor Tak Institute of Global Economics and Finance, The Chinese University of Hong Kong, 12 Chak Cheung Street, Shatin N.T., Hong Kong;3. Department of International Economics and Trade, Nanjing University, China;4. Faculty of Business Administration, University of Macau, E22, Avenida da Universidade, Taipa, Macau, China;1. European Investment Bank, 98-100 Boulevard Konrad Adenauer, 2950 Luxembourg, Luxembourg;2. VU University Amsterdam, De Boelelaan 1105, 1081 HV Amsterdam, The Netherlands;3. Center for Nonlinear Dynamics in Economics and Finance, University of Amsterdam, Valckenierstraat 65-67, 1018 XE Amsterdam, Netherlands;1. College of Finance and Statistics, Hunan University, Changsha, 410006, China;2. School of Economics, Chung-Ang University, 84 Heukseok-Ro, Dongjak-Gu, Seoul, South Korea |
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| 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. |
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| Keywords: | Heterogeneity Stock–bond comovement Markov switching VAR Threshold VAR |
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