Full length articleAn examination of co-movements of India's stock and government bond markets

•India's stock and bond markets are found to be cointegrated with the five foreign equity indices, sharing at most two cointegrating vectors. Further, India's stock and government bond markets are bilaterally cointegrated, sharing one cointegrating vector.•A VECM with TGARCH errors is estimated for India's stock and bond returns using Constant and Dynamic Conditional Correlation specifications.•Unconditional and Constant Conditional correlations understate benefits from diversifying across India's stock and bond markets. Dynamic Conditional Correlations are predictable using the same conditioning variables used to explain time-variation of India's stock and bond expected returns.•Dynamic conditional correlations are a better characterization than a Constant Conditional Correlation between India's stock and bond returns.

We examine the dynamics of India's stock and government bond markets, and their interrelationships with stock markets of the U.S., U.K., Japan, China, and Emerging Equity Markets using multivariate cointegration tests. We find that India's stock and bond markets share two cointegrating vectors with the five foreign equity markets, suggesting full integration is far from complete. Further, India's stock and bond markets share one cointegrating vector, indicating the two markets are tied together by one long-run cointegrating relationship. We estimate dynamic conditional correlations between India's stock and bond returns, and find that unconditional and constant conditional correlations understate dynamic conditional correlations, implying greater ex-ante diversification benefits from combining India's stocks and bonds in one portfolio. We are able to explain a good portion of the variability in estimated dynamic conditional correlations using many of the conditioning variables used to explain temporal variations of India's expected stock and bond returns.