Stock and bond returns in Europe with the European Central Bank

Abstract: This paper examines the relationships between stock and bond returns for key European countries after the establishing of the European Central Bank (ECB) and the introduction of the Euro. It investigates the impact of the ECB monetary policy on stock and bond returns in Germany, Spain, France and Italy. The relations are investigated using vector autoregressive models. Stock and bond returns are found to affect each other in different ways. While shocks to the bond returns have positive impact on stock returns, shocks to the stock returns have negative impact on bond returns. Monetary policy is investigated using a modified Taylor rule. Shocks to the Euribor rate are found to significantly impact on both stock and bond returns in the studied countries. The Euribor rate in turn response to changes in inflation and unemployment gaps.