Macroeconomic determinants of European stock and government bond correlations: A tale of two regions

This paper studies the dynamic correlation between stocks, between government bonds and between stocks and bonds within the Euro-zone in the last decade. In order to better understand the development of the financial market we argue that it is necessary to analyze all such relations simultaneously rather than focus at one. We firstly calculate the dynamic correlation for the previous asset classes. Results presented at the asset-region level, i.e. north-stock, north-bonds, south-stocks and south-bonds, visualize the divergence in integration in Europe and highlight the heterogeneity in these markets. Secondly, we study the macroeconomic factors that determine these correlations. We find that, when we allow for regional division, not only cross-asset correlations within regions behave differently from each other, but also cross-assets cross-regions dynamic correlations can be explained with macroeconomic factors such as the relative market uncertainty between countries and balance of payments dynamics.