Forecasting Stock-Bond Correlation

The forecasts of correlations between asset class returns are at the heart of numerous portfolio optimization efforts worldwide and affect the asset allocation of trillions of dollars. In particular, the assumed correlation between stocks and bonds returns has a major impact on the strategic asset class split of investment portfolios. This article provides some empirical facts about US stock-bond correlation and provides a parsimonious way to tackle correlation forecasting problems as a standard time-series forecast. An empirical forecasting horse race shows that pragmatic parsimonious models provide optimal results while adding complexity or exogenous macro or financial variables didn't improve results.