Real-World Key Correlation: Estimating and explaining the bond-equity return correlation
Document ID: 2008-1021 (previously 2008/07)
Published on: 3rd October 2008
Financial decision making depends on assumptions on the joint distribution of different asset returns. In both risk management and portfolio allocation work (such as the mean-variance framework) correlation assumptions coupled with volatility assumptions determine choices. Stocks and (default free) bonds represent a large fraction of total wealth invested in financial assets. For this reason, an interaction between these two asset classes has important implications for the investment and savings industry. In Barrie & Hibbert’s Economic Scenario Generator (ESG) models we make assumptions about the long-term, unconditional correlation between bond and stock returns. This note explains how we determine assumptions for this important variable.
