Template-Type: ReDIF-Paper 1.0
Author-Name: Andrea Terzi
Author-X-Name-First: Andrea 
Author-X-Name-Last: Terzi
Author-Email: andrea.terzi@unicatt.it
Author-Workplace-Name: DISCE, Università Cattolica
Author-Name: Giovanni Verga
Author-X-Name-First: Giovanni
Author-X-Name-Last: Verga
Author-Email: giovanni.verga@unipr.it
Author-Workplace-Name: Università di Parma
Title: Stock-bond correlation and the bond quality ratio: Removing the discount factor to generate a “deflated” stock index
Abstract: This paper investigates the cyclical co-movements between US stocks and interest rates by testing a simple model where divergence between stock and bond price behavior is 
explained by “stock market strength,” where the latter depends on the market climate
about future corporate profits—as captured by the corporate bond quality ratio—and an
unexplained stock market sentiment. Using two different regression techniques to check
for robustness, we find evidence of a statistically significant cyclical correlation
between stocks and bonds. On the basis of this finding, we then present a methodology
to “deflate” a stock price index such that we can compare stock market strength over
time. This is obtained by removing the effect of a changing discount rate—as measured
by our regressions—on stock prices. For example, viewed in this light, the past five
years in the US stock market reveal a wider fluctuation in stock market strength than we
can observe on the basis of stock price indices alone.
Length: 23 pages
Creation-Date: 2006-09
File-URL: http://www.unicatt.it/Istituti/EconomiaFinanza/Quaderni/ief0067.pdf
File-Format: Application/pdf
File-Function: First version, 2006
Number: ief0067
Classification-JEL: D84, G12, G14
Keywords: Stock-bond correlation, Market sentiment, Stock price.
Handle: RePEc:ctc:serie3:ief0067