3.2 Bond Markets
In this subsection we look at potential co-movements of bond prices and real GDP growth.
Again a positive co-movement of capital gains on bond markets and real GDP growth
would facilitate international risk sharing. However, a negative coefficient implies that a
short position in the bond market by foreign investors serves as a hedge against macroe-
conomic output fluctuations via foreign liability positions.
In order to account for a broad range of portfolio debt securities we construct a
bond price index which includes two-year and ten-year government bonds. Then the
un-weighted annual real rate of capital gains is calculated. The panel specification is in
the same fashion as for equity:
BNDKGit = αi + δt + βgit + uit (5)
eit = ρeit-1 + zit
where BNDKG is the constructed annual real rate of capital gains on the domestic bond
market and g is the annual real rate of domestic GDP growth.
In terms of domestic currencies (Table 4) the coefficient -1.14 (-1 in US dollars) is
significant (at the 1% level) and a coefficient of -0.57 is obtained with time fixed effects.
In US dollars the coefficient is insignificant when we include time fixed effects. These
results imply that higher domestic output growth moves in line with lower prices on the
domestic bond market. Intuitively this relation has some appeal, when we suppose that
periods of higher interest rates (and thus lower bond prices) occur contemporaneously
with economic booms. In gloomy economic periods, on the other hand, lower interest
rates in order to stimulate the economy could drive bond prices up. These relations are
supported by the findings for individual countries, where we run
BNDKGit = αi + βigit + eit (6)
eit = ρeit-1 + zit
We observe counter-cyclicality also for the majority of countries (Table 5). Exceptions
are Australia, Canada, Sweden and the United Kingdom for whom no significant relation is
found. The largest coefficient in absolute value terms is noticeable for Switzerland (-4.15).
Consequently, there is no pro-cyclical (thus wealth stabilising) co-movement observable
through bond markets. However, it holds true that short positions in bond holdings are
useful hedging instruments as suggested above.