Integration of EU Stock and Bond Markets: Uncertainty and Expectation

This paper sheds light the impacts of financial market uncertainty and of investors’ expectations about future economic states on time-varying comovemt (i.e., integration) among stocks and 10 year government bonds in Europe. As a proxy of dynamic comovemnt of financial asset markets, we measure realized correlations between stock and bond returns among 13 EU countries. To this end, we employ the panel data analysis technique with the realized correlations among our sample EU stock and bond returns. We in this study present empirical evidence that the lower VDAX, the proxy for financial market uncertainty, has significantly contributed to an increase in dynamic integration among EU stock and bond markets. The result supports the flight to quality hypothesis to explain interdependence of EU asset markets. Meanwhile, the EU_ESI, the proxy for the future state of EU Economy, have made a positive relation with integration of the EU asset markets. This finding supports the wealth effect hypothesis for explaining the comovement of the EU asset markets. Shortly, Our major findings suggest that investors’ perceptions about future state of the economy and financial market uncertainty are crucially associated with time-varying comovement of EU stock and government bond markets. This study provides valuable implications for international investors and policy makers. That is, the dynamic integration of the EU asset markets should be a crucial concern for investors' efficient diversification and for policy makers' coordination for stabilizing financial markets at the times of financial turmoils in Europe, respectively.