Correlation between Stock and Bond market in UK

Shuja, Rohama (2020) Correlation between Stock and Bond market in UK. [Dissertation (University of Nottingham only)]

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Abstract

The scope of the study was aimed to give investors a glimpse of correlation between the stock market and the bond market. This study has an important implication for the portfolio managers and that is the relationship studied between the bond market volatility and the stock market volatility. This relationship is crucial in asset allocation decisions.

The empirical results for the monthly returns of stock and bond market shows that the correlation between the return series of the two asset classes which are proved to be stationary series, is positive as evaluated by the rolling window correlation model, for the period of January 2010 to January 2020.The rolling window correlation shows that stock and bond returns are positive in the UK market for the given time period with mean estimation of 0.00628. However, it is not as significant for investors to believe in and make decisions for their portfolio adjustments. The ARCH(1) process indicated that if returns are low in the past it will be high in current period. The time series trend of the moving standard deviations indicates that the volatilities in both markets do not generally move together. We discovered negative correlation or no correlation at all which is a positive news for the investor. However the graph is upward trending.

As far as ratio of the bond to stock standard deviations, the range of the ratios can be seen from the graph is 0 to 1.5. In addition to this substantial change, significant positive upward trend can be seen in the ratio of the volatility. This implies that there has been an increase in bond market volatility more than in stock market volatility.

The relationship between the measures of volatility cannot be seen as stable. It can be said that stock market volatility measure is almost about more than three times of that bond market from the table but yet it cannot be established that there exists any kind of statistically significant relationship that can be used to predict future expectations in both the market.

There was a time period for example in 2017 when both the ratio of the standard deviations and beta are increasing which implies that bond volatility increased more than stock volatility and bonds were highly correlated with the stocks.

The major conclusion this paper was successful in finding is that the moving beta trends upwards from 2010 to 2019 as the regression turns from significantly negative to now being positive. This result is consistent with many studies in existing literature which proved the correlation turning into negative in the recent years such as Ilmanen (2003) and Steeley (2005).

Upward trend can be seen in the plot of the moving beta but also instability of the correlation is noticeable. This unstable relationship is explained by factors that affect the asset prices.

The implication of regression now being positive from negative is that diversification benefit of including both stocks and bonds in a portfolio is decreased. This means investors allocating smaller portion of bonds in a portfolio.

Item Type: Dissertation (University of Nottingham only)
Depositing User: Shuja, Rohama
Date Deposited: 08 Jun 2021 11:40
Last Modified: 08 Jun 2021 11:40
URI: http://eprints.nottingham.ac.uk/id/eprint/63201

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