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

Abstract

In contrast to the well-known unstable relationship between the returns on government bonds and stock indices, we find that bonds are robustly related to the cross-section of stock returns in both comovement and predictability patterns. 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. Time-series variables already known to predict returns on bonds also predict returns on bond-like stocks, and vice-versa. These relationships remain in place even when bonds and stocks become “decoupled” at the index level. They are likely 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.

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