Research Review: Stocks, Bonds, and Causality

Gamma Paradigm studies dynamic stock-bond allocation in our Adaptive Beta strategy. Simple observation on the correlation between the two assets cannot create a reactive model, and the research gives a good overview.

In short, the article emphasizes the importance to take the market-valuation into account when using bonds for hedging. Low equity risk premium often leads to lower real yield (high bond price) in the future. Therefore the hedging will be more effective.

Market volatilities also provide a hint on the impact of the asset relationship. High real-yield volatility might lead to positive stock-bond correlation. That means the sudden movements from the Federal Reserve would weaken US Treasury bond’s hedging power. This phenomenon coincides with the market movements during the rate hikes in the past few years.

Stock, Bonds, and Causality, J. Baz, S. Sapra, and G. Ramirez, The Journal of Portfolio Management, 45 (4)
https://jpm.pm-research.com/content/45/4/37