The flight-to-quality effect: a copula-based analysis


  • The authors thank participants at the conference ‘Probability, Financial Derivatives, and Asset Pricing’, Charlottesville, USA, 2005, for helpful comments; we have particularly benefited from advice given by, and discussions with, David Bates, Paul Embrechts, Wake Epps, Dilip Madan, Ross Maller, Sid Resnick, Len Scott and Kent Zumwalt. We also thank participants at seminars at the Australian National University for their thoughts on the paper. Thanks are also due to Mark Moore for assistance with the data.


We derive and estimate a copula combining the features of the Frank and Gumbel copulas to analyse the relationship between equity and long-term bond returns. Our analysis of quarterly returns from 1952 to 2003 finds that, in general, there is a positive relationship between equity returns and bond returns. In extreme situations, however, there is approximately a one-in-seven chance of a flight-to-quality effect where large negative equity returns are associated with large positive bond returns.