The equity-like behaviour of sovereign bonds

Dufour, Alfonso, Stancu, Andrei and Varotto, Simone (2017) The equity-like behaviour of sovereign bonds. Journal of International Financial Markets, Institutions & Money, 48. pp. 25-46. ISSN 1042-4431

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Using a rich dataset of high frequency historical information from 2004 to 2013 we study the determinants of European sovereign bond returns over calm and crisis periods. We find that the sign of the equity beta crucially depends on country risk. In low risk countries, government bonds represent a natural hedge against equity risk as the equity beta is negative regardless of market conditions. On the other hand, government bonds of high risk countries lose their “safe-asset” status and exhibit more equity-like behaviour during the sovereign debt crisis, with positive and strongly significant co-movements relative to the stock market. Our estimates indicate that the equity beta switches from negative to positive when a sovereign’s credit spread rises above 2%. We find that the decoupling of the government bond market between high risk and low risk countries implies that indiscriminate portfolio diversification does not pay. Instead, “prudent diversification” appears to offer superior risk adjusted returns in periods of sovereign stress and through the economic cycle.

Item Type: Article
Uncontrolled Keywords: government bonds,stock-bond co-movements,subprime crisis,sovereign debt crisis,credit risk,liquidity risk
Faculty \ School: Faculty of Social Sciences > Norwich Business School
UEA Research Groups: Faculty of Social Sciences > Research Groups > Finance Group
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Depositing User: Pure Connector
Date Deposited: 14 Dec 2016 00:06
Last Modified: 22 Oct 2022 01:59
DOI: 10.1016/j.intfin.2016.11.014

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