Identifying safe haven assets for equity investors through an analysis of the stability of shock transmission

• We seek to identify safe haven assets from the perspective of a U.S. equity investor.
• We analyse the suitability of gold, 10- and 1-year Treasury bonds.
• Our regime-switching model decomposes returns into common and idiosyncratic factors.
• Both gold and long-term Treasury bonds satisfy our definition of a safe haven asset.
• The equity-1-year bond combination exhibits bi-directional contagion.

Our analysis takes the perspective of an equity fund manager who seeks a potential safe haven asset to protect her portfolio during market downturns. We employ a regime-switching framework, within which we separate common and idiosyncratic shocks, to assess the suitability of gold, 10-year and 1-year U.S. Treasury bonds. We find evidence in favour of choosing either gold or the longer-dated bond as our safe haven asset. Both deliver risk reduction benefits as equity markets plunge. In contrast, the 1-year bond is not suitable as its vulnerability to contagious idiosyncratic shocks more than offsets its ability to hedge against common risk factors.