Correlation between bond yields and stock returns?

Question

I intend to regress the correlation coefficient (rolling window and/or DCC) between NIKKEI 225 adjusted close and 10yr Japanese government bonds on inflation , inflation expectations and other factor which may or may not be important in order to evaluate their relative impact on the correlation coefficient.

However, I can't seem to find a sophisticated enough explanation for the correlation's existence other than the changing dynamics of the demand for these asset classes (viewing them as substitutes).

A discounted dividends model suggest a strictly positive relationship, but the data suggests otherwise.

What are the fundamental reasons for the correlation between stock returns and government bond yields that would explain the correlation switching signs?

Answer 1

Why do you say a DDM suggests a positive relationship between govt bond yield and stock price ? If yield gets higher the present value of future dividends is lower (maintaining risk premium and dividend growth constant).

Also the discount rate is bond yield + risk premium and the risk premium is inversely correlated with the govt bond yield so these effects tend to at least cancel out (during an economic crisis govt bond yields go down but risk premium goes up usually more, furthermore dividend and estimated dividend growth are also lower).