David G. McMillan

Understanding the linkages between real and financial markets is important for a range of economic agents, including policymakers, investors (in both market types) and those engaged in modelling behaviour. This paper argues that financial market correlations (both across international stocks and between stocks and bonds) carries information about subsequent economic conditions. Higher perceived risk results in investor selling all stocks (higher stock correlation) and buying bonds (lower stock and bond correlation), such that a movement in correlations acts as an indicator of future performance. Where investors expect more benign economic conditions, they are more likely to build a balanced stock and bond portfolio (lower stock and higher stock and bond correlations). Using a monthly G7 data set, correlations (constructed from daily data) reveal a negative relation from international stock correlations and a positive relation from stock and bonds correlations for subsequent economic growth and stock returns. The predictive results are robust to the inclusion of alternative risk measures, suggesting that the correlations contain unique information, and to alternative (confounding) views (and modelling) on the relation between risk and the correlations. Further robustness checks involve different approaches for construction of the correlation series and sample periods. While movements in these correlations provide signals to a range of agents, we examine the likely drivers of the predictive relation as an important extension. This reveals that the correlations appear to impact demand-side factors (consumption and inflation) rather than supply-side (investment and productivity). Overall, this paper provides information both in the form of signals for policymakers and investors to act, as well as to enhance our understanding of the linkages between real and financial markets.

We investigate the impact of changes in U.S. monetary policy on portfolio diversification. We build four different types of portfolios, including a U.S.‐only, a stock‐bond (60/40) portfolio, an international diversified stock portfolio, and an asset diversified portfolio. Our assets include the S&P 500 index, a developed market index (MSCI EAFE), an emerging market index (MSCI EM), gold, oil, and U.S. 10‐year Treasury notes (10‐year T‐Note). We provide the following evidence. First, U.S. monetary policy is a risk factor in these global asset markets. Second, the results demonstrate that these markets, except for the 10‐year Treasury notes, are unlikely to react to anticipated monetary policy changes. Third, we suggest that risk‐averse investors can use U.S. 10‐year Treasury notes and choose the stock‐bond portfolio to hedge risks when monetary policy is volatile, as we find that all stock indexes, gold and oil respond more to U.S. monetary policy surprises than 10‐year Treasury notes. Fourth, all portfolios are negatively related to the monetary policy surprise, and we contend that U.S. monetary policy may be a systemic risk that cannot be fully diversified.

The banking and financial services sector continues to undergo transformative and disruptive processes that not only challenge its traditional foundations but create both new opportunities and risk...

This paper uses over twenty years of data to examine diversification benefits for U.S. investors through assessing different portfolio opportunities, including a stock (60%)-bond (40%) portfolio, an internationally diversified stock portfolio, and a cross-asset diversified portfolio compared with investing only in the U.S. stock market. Our dataset consists of three stock indices (S&P 500, MSCI EAFE, and MSCI EM) and three assets (Gold, Oil, and Bonds). Portfolios are built using both equal- and mean-variance efficient-weights and are compared primarily using the Sharpe ratio. The results indicate that before 2009, U.S. investors could benefit from an internationally diversified stock portfolio. However, since 2009, this international stock portfolio is less likely to benefit U.S. investors. In contrast, the cross-asset diversified portfolio does provide greater benefit and outperforms the U.S only, the stock–bond portfolio, and the international stock portfolio over different time periods. Of note, the mean-variance efficient portfolio weighting outperforms the equal-weighted portfolio. Overall, a portfolio consisting of the S&P500 Index, gold, oil, and U.S. 10-year Treasury Note is the preferred option for U.S. investors.

This paper evaluates the roles of jump and sign‐asymmetry spillovers in forecasting the realized volatility in a large sample of 20 stock markets. We compare for the first time whether controlling for either the jumps or asymmetric spillovers into the heterogeneous autoregressive–realized volatility (HAR‐RV) model improves the forecasts over 1, 5 and 22 days. Before doing so, the spillovers predictors are generated. In analyzing the spillover process, we find that the US stock market remains the main net transmitter of shocks, and while China is relatively detached from the spillover linkages, such effects may be transmitted through Hong Kong, which is a significant receiver of shocks. The out‐of‐sample results reveal that the incorporation of jump spillovers improves forecast performance the most across a range of measures. This is more clearly demonstrated at the 22‐day forecasting horizon more notably in Europe, France, Germany, India, and the United Kingdom. Lastly, irrespective of the forecasting horizon, performing the predicting stability test uncovers significant improvements in the jump spillover–based model during periods of notable market stress such as the 2014–2016 oil price crash and COVID‐19. Overall, results suggest paying more attention to jump spillover while constructing international portfolios based on the realized volatility.

After a period of approximately 20 years where a negative stock-bond return correlation prevailed, this paper argues that this relation is now positive. This is due to the rise in recent inflation, which is now the dominant macroeconomic risk, as it was from the 1970s when the correlation previously turned positive. We present evidence that the low level of inflation (and potential deflation) since 2000 led to a positive relation between inflation and both stock returns and growth, as higher inflation indicated improving economic conditions. Following events of the early 2020s, these relations are reversing. This has implications for portfolio management as well as theoretical models.