Top

Financial Markets and Portfolio Management

Published in:

31-07-2020

Flight-to-quality in the stock–bond return relation: a regime-switching copula approach

Published in: Financial Markets and Portfolio Management | Issue 4/2020

Activate our intelligent search to find suitable subject content or patents.

search-config

AI-assisted search

Off

Abstract

This paper examines the existence, intensity and international dependence of flight-to-quality from stocks to government bonds. To this end, we develop a two-state regime-switching bivariate copula model and apply it to the domestic and cross-country stock–bond return pairs of six developed countries (France, Germany, Japan, Switzerland, the UK and the US) over the period 1999–2019. We find that US and UK government bonds have played a primary role of safe-haven assets during stock market downturns. The remaining government bond markets show the evidence of flight-to-quality, but its intensity is relatively weak. Further, we find that although flight-to-quality tends to occur simultaneously in multiple countries, the frequency of the joint occurrence varies across government bond markets.

previous article Time-consistent mean–variance asset-liability management in a regime-switching jump-diffusion market

next article Dominance of hybrid contratum strategies over momentum and contrarian strategies: half a century of evidence

Dont have a licence yet? Then find out more about our products and how to get one now:

Springer Professional "Wirtschaft+Technik"

Online-Abonnement

Mit Springer Professional "Wirtschaft+Technik" erhalten Sie Zugriff auf:

über 102.000 Bücher
über 537 Zeitschriften

aus folgenden Fachgebieten:

Automobil + Motoren
Bauwesen + Immobilien
Business IT + Informatik
Elektrotechnik + Elektronik
Energie + Nachhaltigkeit
Finance + Banking
Management + Führung
Marketing + Vertrieb
Maschinenbau + Werkstoffe
Versicherung + Risiko

Jetzt Wissensvorsprung sichern!

inform now

Springer Professional "Wirtschaft"

Online-Abonnement

Mit Springer Professional "Wirtschaft" erhalten Sie Zugriff auf:

über 67.000 Bücher
über 340 Zeitschriften

aus folgenden Fachgebieten:

Bauwesen + Immobilien
Business IT + Informatik
Finance + Banking
Management + Führung
Marketing + Vertrieb
Versicherung + Risiko

Jetzt Wissensvorsprung sichern!

inform now

Early studies that introduce a RS framework into copulas are Chollete et al. (2009), Jondeau and Rockinger (2006), Okimoto (2008) and Rodriguez (2007) in which the dependence structure of international stock markets is investigated.

Garcia and Tsafack (2011) analyze the dependence structure between four variables (stock and government bond returns of two countries). Extending our bivariate model to multivariate distributions requires substantial computational burden, and thus, we leave it to future work.

Durand et al. (2010) derive a copula function that combines Frank and Gumbel copulas to capture both a normal situation of positive correlation and a rare event of flight-to-quality between stock and bond markets. This is a very flexible model, but our RS copula model is more flexible in that asymmetric copulas other than Gumbel (Clayton and Joe in this paper) can be used for describing an asymmetric regime.

Hartmann et al. (2004) find that stock–bond contagion is approximately as frequent as flight-to-quality from stocks to bonds in G-5 countries over the period 1987–1999. However, our earlier analysis presents no evidence on the contagion over the period 1999–2019, and hence, this paper only studies flight-to-quality phenomena.

Note, however, that the differences between the unconditional means of the two returns do not affect the estimation result of the dependence structure because they are removed in the copula approach by filtering the conditional mean and variance of marginal distributions.

We do not report the standard errors and significance of the exceedance correlation estimates in the table because the t-test using the standard errors leads to the same result as the Wald test for \(H_0: \rho = \rho ^{\mathrm{{asy}}}_{\mathrm{{nor}}} = 0\).

See Appendix 1 in Longin and Solnik (2001) for the method to compute the optimal threshold values.

See Joe (1997, (2015) and Nelsen (2006) for a comprehensive exposition of copulas.

The starting value \(\xi _{1|0}\) is set equal to the vector of unconditional probabilities for two states, that is, \([(1-p_{22})/(2-p_{11}-p_{22}), (1-p_{11})/(2-p_{11}-p_{22})]'\).

To save space, we do not report the estimated coefficients on the ARMA and GARCH terms as they are relatively less informative. These results are available from the authors upon request.

The delta method is used to compute standard errors for the estimates of Kendall’s \(\tau \) and LU tail dependence.

There are two exceptions, UK–JP and US–JP (Table 10), for which incorrect estimates are obtained (bounded estimates of 0.5 for the transition probabilities and very large standard errors). Thus, for the two pairs, we regard the normal–asymmetric RS copula model reported in Panel A as the most appropriate model, but its normal regime, rather than the asymmetric one, as a regime to describe flight-to-quality events.

There are two slight differences, which are explained in the subsequent two footnotes. The whole of the results with a threshold value of 0.15 is available from the authors upon request.

When relying on the different definition of flight-to-quality with a threshold value of 0.15, there are three cases where domestic flight-to-quality simultaneously occurs in all countries.

For the different definition of flight-to-quality with a threshold value of 0.15, the ratio for Switzerland is low compared to the other three European countries. This suggests some degree of independence of Swiss financial markets from the three European countries.

Andersson, M., Krylova, E., Vähämaa, S.: Why does the correlation between stock and bond returns vary over time? Appl. Financ. Econ. 18, 139–151 (2008)CrossRef

Aslanidis, N., Christiansen, C.: Smooth transition patterns in the realized stock–bond correlation. J. Empir. Finance 19, 454–464 (2012)CrossRef

Bansal, N., Connolly, R.A., Stivers, C.: Regime-switching in stock index and treasury futures returns and measures of stock market stress. J. Futures Mark. 30, 753–779 (2010)

Baur, D.G., Lucey, B.M.: Flights and contagion—an empirical analysis of stock–bond correlations. J. Financ. Stab. 5, 339–352 (2009)CrossRef

Bedford, T., Cooke, R.M.: Probability density decomposition for conditionally dependent random variables modeled by vines. Ann. Math. Artif. Intell. 32, 245–268 (2001)CrossRef

Bedford, T., Cooke, R.M.: Vines—a new graphical model for dependent random variables. Ann. Stat. 30, 1031–1068 (2002)CrossRef

Chang, C.-L., Hsueh, P.L.: An investigation of the flight-to-quality effect: evidence from Asia-Pacific countries. Emerg. Mark. Finance Trade 49, 53–69 (2013)CrossRef

Chen, X.B., Silvapulle, P., Silvapulle, M.: A semiparametric approach to value-at-risk, expected shortfall and optimum asset allocation in stock–bond portfolios. Econ. Model. 42, 230–242 (2014)CrossRef

Chiang, T.C., Li, J., Yang, S.-Y.: Dynamic stock–bond return correlations and financial market uncertainty. Rev. Quant. Financ. Acc. 45, 59–88 (2015)CrossRef

Chollete, L., Heinen, A., Valdesogo, A.: Modeling international financial returns with a multivariate regime-switching copula. J. Financ. Econom. 7, 437–480 (2009)CrossRef

Chui, C.M., Yang, J.: Extreme correlation of stock and bond futures markets: international evidence. Financ. Rev. 47, 565–87 (2012)CrossRef

Connolly, R., Stivers, C., Sun, L.: Stock market uncertainty and the stock–bond return relation. J. Financ. Quant. Anal. 40, 161–194 (2005)CrossRef

Connolly, R.A., Stivers, C., Sun, L.: Commonality in the time-variation of stock–stock and stock–bond return comovements. J. Financ. Mark. 10, 192–218 (2007)CrossRef

Dajcman, S.: Comovement between Stock and bond markets and the ’flight-to-quality’ during financial market turmoil—a case of the eurozone countries most affected by the sovereign debt crisis of 2010–2011. Appl. Econ. Lett. 19, 1655–1662 (2012)CrossRef

Durand, R.B., Junker, M., Szimayer, A.: The flight-to-quality effect: a copula-based analysis. Account. Finance 50, 281–299 (2010)CrossRef

Fatum, R., Yamamoto, Y.: Intra-safe haven currency behavior during the global financial crisis. J. Int. Money Finance 66, 49–64 (2016)CrossRef

Garcia, R., Tsafack, G.: Dependence structure and extreme comovements in international equity and bond markets. J. Bank. Finance 35, 1954–1970 (2011)CrossRef

Glosten, L.R., Jagannathan, R., Runkle, D.E.: On the relation between the expected value and the volatility of the nominal excess return on stocks. J. Finance 48, 1779–1801 (1993)CrossRef

Gulko, L.: Decoupling: If the U.S. treasury repays its debt, what then? J. Portf. Manag. 28, 59–66 (2002)CrossRef

Hamilton, J.: Time Series Analysis. Princeton University Press, Princeton (1994)

Hansen, B.E.: Autoregressive conditional density estimation. Int. Econ. Rev. 35, 705–730 (1994)CrossRef

Hartmann, P., Straetmans, S., de Vries, C.G.: Asset market linkages in crisis periods. Rev. Econ. Stat. 86, 313–326 (2004)CrossRef

Ilmanen, A.: Stock–bond correlations. J. Fixed Income Fall 13, 55–66 (2003)CrossRef

Jammazi, R., Tiwari, A.K., Ferrer, R., Moya, P.: Time-varying dependence between stock and government bond returns: international evidence with dynamic copulas. N. Am. J. Econ. Finance 33, 74–93 (2015)CrossRef

Joe, H.: Multivariate Models and Dependence Concepts. Chapman & Hall, London (1997)CrossRef

Joe, H.: Dependence Modeling with Copulas. CRC Press, Boca Raton (2015)

Joe, H., Xu, J.J.: The Estimation Method of Inference Functions for Margins for Multivariate Models. Technical Report No. 166, Department of Statistics, University of British Columbia (1996)

Jondeau, E., Rockinger, M.: The Copula-GARCH model of conditional dependencies: an international stock market application. J. Int. Money Finance 25, 827–853 (2006)CrossRef

Kim, S.-J., Moshirian, F., Wu, E.: Evolution of international stock and bond market integration: influence of the European monetary union. J. Bank. Finance 30, 1507–1534 (2006)CrossRef

Krupskii, P., Joe, H.: Factor copula models for multivariate data. J. Multivar. Anal. 120, 85–101 (2013)CrossRef

Krupskii, P., Joe, H.: Structured factor copula models: theory, inference and computation. J. Multivar. Anal. 138, 53–73 (2015)CrossRef

Longin, F., Solnik, B.: Extreme correlation of international equity markets. J. Finance 56, 649–676 (2001)CrossRef

Nelsen, R.B.: An Introduction to Copulas. Springer, Berlin (2006)

Nguyen, P., Liu, W.: Time-varying linkage of possible safe haven assets: a cross-market and cross-asset analysis. Int. Rev. Finance 17, 43–76 (2017)CrossRef

Ohmi, H., Okimoto, T.: Trends in stock–bond correlations. Appl. Econ. 48, 536–552 (2016)CrossRef

Okimoto, T.: New evidence of asymmetric dependence structures in international equity markets. J. Financ. Quant. Anal. 43, 787–815 (2008)CrossRef

Patton, A.J.: Modelling asymmetric exchange rate dependence. Int. Econ. Rev. 47, 527–556 (2006)CrossRef

Patton, A.J.: Copula-based models for financial time series. In: Andersen, T.G., Davis, R.A., Kreiß, J.-P., Mikosch, T. (eds.) Handbook of Financial Time Series, pp. 767–785. Springer, Berlin (2009)CrossRef

Ranaldo, A., Söderlind, P.: Safe haven currencies. Rev. Finance 14, 385–407 (2010)CrossRef

Rodriguez, J.C.: Measuring financial contagion: a copula approach. J. Empir. Finance 14, 401–423 (2007)CrossRef

Wu, C.-C., Lin, Z.-Y.: An economic evaluation of stock–bond return comovements with copula-based GARCH models. Quant. Finance 14, 1283–1296 (2014)CrossRef

Title: Flight-to-quality in the stock–bond return relation: a regime-switching copula approach
Publication date: 31-07-2020
Published in: Financial Markets and Portfolio Management / Issue 4/2020
Print ISSN: 1934-4554
Electronic ISSN: 2373-8529
DOI: https://doi.org/10.1007/s11408-020-00361-5

Springer Professional

Abstract

Please log in to get access to your license.

Dont have a licence yet? Then find out more about our products and how to get one now:

Springer Professional "Wirtschaft+Technik"

Springer Professional "Wirtschaft"

Other articles of this Issue 4/2020

Marcos M. López de Prado: Machine learning for asset managers

Dominance of hybrid contratum strategies over momentum and contrarian strategies: half a century of evidence

Behavioral portfolio insurance strategies

Time-consistent mean–variance asset-liability management in a regime-switching jump-diffusion market