Study On The Correlation Of China's Stock And Bond Markets And Its Determinants

Stock and bond play key roles in the financial market. Both financial regulatory departments and market investors are interested in the issue of how stock and bond markets are correlated and what factor may affect their co-movements. On one hand, financial regulatory departments are able to judge the effectiveness of regulatory policies based on the stock-bond correlation. Understanding the potential determinants of this correlation can further help them forecast the market reactions to certain regulatory policy. On the other hand, many market investors, such as insurance companies and assets management corporations, are required to understand the stock-bond correlation and its determinants, as the cross-market correlation is useful in portfolio optimization and risk management. Therefore, studying the stockbond correlation and its potential determinants has theoretical and empirical implications for both financial regulatory departments and market investors.Under this motivation, this paper analyzes the correlation between CSI300 and short-and-medium-term bond index and the correlation between CSI300 and longterm bond index from 2003 and 2013. The paper focuses on discussing the potential factors affecting the stock and bond co-movements. Two questions are answered. One is how the dynamic stock-bond correlation evolves over the time. The other is what economic factors may significantly affect the stock and bond co-movements. Some multivariate econometric models are established to study the dependence structure of CSI300, short-and-medium-term bond and long-term bond. First, the lead-lag relationship between stock and bond markets is analyzed based on the vector autoregressive model at the average return level(first moment). Then, the information spillover effect is investigated based on the dynamic conditional correlation model from the perspective of volatility and correlation(second moment). Last, the paper analyzes the impacts of macroeconomic fundamentals and microstructure liquidity factors on the stock-bond co-movements by running the linear regression of the stock-bond correlation on its potential economic explanatory variables.Three points can be concluded from the empirical analysis. First, from the perspective of average return, the information transmission mechanism between stock and bond markets is one-sided. Stock price changes can lead bond price changes, but it is not the case vice versa. The negative impact from stock to longterm bond is stronger than the impact from stock to short-and-medium-term bond. Second, from the perspective of volatility and correlation, the stock and bond markets exhibit dynamic correlation all over the sample period. They are negatively correlated most of the time, but are positively correlated occasionally. When they are negatively correlated, the dependence between stock and long-term bond is stronger than the dependence between stock and short-and-medium-term bond; when they are positively correlated, the dependence between stock and long-term bond is weaker than the dependence between stock and short-and-medium-term bond. Third, both macroeconomic fundamentals and microstructure liquidity factors exert significant impacts on the stock and bond co-movements, and they are equally important. Among the macroeconomic fundamentals, inflation, industrial production growth and interest rate is positively correlated with the stock-bond correlation, while monetary policy is negatively correlated with the stock-bond correlation. Among the microstructure liquidity factors, the stock-bond correlation moves in the same direction with the stock liquidity, but moves in the opposite directions with the bond liquidity.This paper differs from existing studies in two aspects. One is that the paper analyzes the correlation between stock and short-and-medium-term bond and the correlation between stock and long-term bond respectively. Bond is further divided into short-and-medium-term bond and long-term bond. However, few existing studies have ever considered the correlation of stock and bond with different maturities. In fact, bonds with different maturities may include different market expectation information and differ in liquidity levels and risk tolerance of potential investors. Hence it is required to further investigate the correlation of stock and bonds with different lengths of maturities. The other innovation is that this paper studies the impacts of macroeconomic fundamentals and microstructure liquidity factors on the stock and bond co-movements simultaneously. By contrast, most existing studies just examine part of the potential determinants of the stock-bond correlation and lack a comprehensive framework. In this paper both the macroeconomic and microstructure factors are considered, and the conclusion provides important supplementary information for existing studies.