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Market fragility and the paradox of the recent stock-bond dissonance
- Koulovatianos, Christos, Li, Jian, Weber, Fabienne
- Economics letters 2018 v.162 pp. 162-166
- disasters, markets
- After the Lehman-Brothers collapse, the stock index has exceeded its pre-Lehman-Brothers peak by 36% in real terms. Seemingly, markets have been demanding more stocks instead of bonds. Yet, instead of observing higher bond rates, paradoxically, bond rates have been persistently negative after the Lehman-Brothers collapse. To explain this paradox, we suggest that, in the post-Lehman-Brothers period, investors changed their perceptions on disasters, thinking that disasters occur once every 30 years on average, instead of disasters occurring once every 60 years. In our asset-pricing calibration exercise, this rise in perceived market fragility alone can explain the drop in both bond rates and price–dividend ratios observed after the Lehman-Brothers collapse, which indicates that markets mostly demanded bonds instead of stocks.