Time-varying risk of nominal bonds: How important are macroeconomic shocks?

I study the sufficiency of macroeconomic information to explain the time-variation in sec -ond moments of stock and bond returns, with a particular attention to stock-bond correla-tions. I propose an external habit model supplemented with realistic non-Gaussian funda-mentals estimated solely from macroeconomic data. Intertemporal smoothing and precau-tionary savings effects - driven by consumption shocks - combine with a time-varying co-variance between consumption and inflation to generate large positive and negative stock-bond return correlations. Macroeconomic shocks are most important in explaining second moments of stock and bond returns from the late 1970's to mid-1990's and during the Great Recession. (c) 2022 Elsevier B.V. All rights reserved.