Macroeconomic determinants of the time-varying correlation between stock and bond returns: A study of the Swedish market

Abstract: This paper investigates how and to what extent realized fundamental macroeconomic factors affect the time-varying correlation between stock and bond returns on the Swedish financial market. We use daily return data of the OMXS30 and Swedish government bonds, and monthly or quarterly data of macroeconomic factors. We begin by estimating quarterly values of the time-varying correlation between stock and bond returns, using both a sample rolling window model of the Pearson product-moment correlation, and a constant conditional correlation GARCH model. An ordinary least squares multiple regression model is then applied for examining the effect of each macroeconomic factor on the time-varying correlation. Our first finding is that increased realized stock market volatility has a significant negative impact on the correlation, implicating the potential existence of a "flight-to-quality" phenomenon. Our second finding is that currency value also has a significant impact, where a depreciation of the currency tends to increase the correlation. Due to the non-occurrence of research on currency value in this context, three possible explanations are outlined in which the relationship between currency value and inflation expectations, interest rate differentials and the current account, respectively, are discussed.