Stock-Bond Return Dynamics and the Expected Country Stock Returns

Stock and bond prices of a country move together with increasing country-specific risk. Bonds effectively hedge growth expectation risk when country-specific risk is low, resulting in a negative stock-bond correlation. However, as country-specific risk increases, hedging is less effective because (1) rising domestic prices tend to reduce a country’s growth potential and (2) global growth expectation shocks are more persistent than country-specific ones. Consequently, countries with greater country-specific risk exhibit a relatively positive stock-bond correlation. Equity investments in these countries outperform those with negative relationships by 7%–11% annually. The superior performance is not driven by investing in a fixed set of countries. This paper was accepted by Lukas Schmidt, finance. Funding: This work was supported by Yonsei University [Grant 2024-22-0467]. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2024.07047 .