Faculty Research

Andrey Ermolov, Ph.D.

Associate Professor of Finance and Business Economics
Abstract vector of man and woman next to large lightbulb labeled Yield to Maturity
Portfolio managers and investors who were used to U.S. and international bond yields moving in the same direction in the early 2000s should take another look at their diversification strategies.

Research by Andrey Ermolov, Ph.D., associate professor of finance and business economics, shows that since the Great Recession, yields of five-year bonds issued by the U.S. government often moved in a different direction from those of bonds issued by governments in the U.K. and France.

“Most models would predict that prices of government bonds of developed countries would have moved closer together, but that wasn’t the case in the Great Recession,” said Ermolov, who holds the Felix E. Larkin Distinguished Professorship in Management. “Somehow this dependence broke down after the Great Recession.”

Ermolov and his coauthor studied the comovements of yields on nominal bonds and inflation-linked bonds in the three countries between 2004 and 2019. In “International Yield Co-Movements,” published in the Journal of Financial and Quantitative Analysis, they specifically looked at the components of yield–the real rate, or the rate investors receive after accounting for inflation; the expected inflation rate, as measured by professional forecasts; and the inflation risk premium, or the compensation investors demand for bearing the risk of inflation. They also divided the period in two, with the first half including the Great Recession, which ran from late 2007 through mid-2009 and from which it took the world’s developed economies years to recover.

They found that up until 2012, yields for both nominal and inflation-linked bonds moved in a similar positive direction across the three countries. But afterward, the yields on both types of U.S. bonds diverged substantially from the yields on their counterpart U.K. and French bonds. With inflation expectations essentially stable during that period, Ermolov found that in fact, the yields diverged because of differences in the real-rate component of the countries’ bonds.

Why the real rates stopped moving in the same direction is a next step in his research, Ermolov said, but he has some ideas. One possibility is that the countries’ economies recovered from the Great Recession at different paces, influencing the rate each country set for its bonds. The other, more speculative scenario is that the U.S. central bank acted more convincingly during the recession than other central banks. “European central banks started raising interest rates soon after the Great Recession, and it created a certain turmoil in government bond markets… and investor doubt about government bonds of particular countries,” he said.

Another topic for further research is whether the difference in international bond yields continued beyond the spread of the COVID-19 pandemic in 2020 and the subsequent jump in inflation. Ermolov said countries raised their interest rates to different levels, making comovement of bond yields less clear, but another factor to consider is whether inflation is a bigger component of yield than before.

In the meantime, Ermolov said, managers and investors who seek to diversify bond portfolios ought to consider that trends in U.S. and foreign bond yields can differ.

“The main finding of the paper is that these correlations vary over time,” he said. “Will they stay low or high? This might change, but you just shouldn’t assume that they are constant.”

— Jane Larson