Correlations Can Be Predictive

Academic researchers have presented theory, as well as empirical evidence, suggesting certain linkages between equity risk and the Treasury bond market, a relationship that clearly has important implications for investors’ understanding of markets and portfolio design.

Studies, for example, have found that greater economic uncertainty leads both to higher equity volatility and increased motives for precautionary savings that can depress interest rates. Moreover, links between the stock and bond markets have been attributed to flight-to-quality (FTQ) or flight-from-quality (FFQ) as some investors move between riskier stocks and safer Treasurys due to changing perceptions of risk.

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