A new study examined the factors that affect flight-to-quality episodes.

A flight to quality is a shift in allocation from risky assets to safer assets. A flight to quality is technically defined as a change in market dynamic, with riskier assets experiencing negative returns and safer assets experiencing positive returns during the crisis window.

Flights are more common when the average stock return during the month is “exceptionally unfavorable, i.e. below its annual average.” The researchers found that the relative frequency in which flights occurred between 1990 and 2014 was 24.0% during down markets, versus 12.8% during up markets.

Not all flights are the same, however. “Extremely bad days” for stocks increase the probability of flights into Treasury bills, but not long-term Treasuries and corporate bonds. The study’s authors noted that the “extreme types of negative shocks…make short-term Treasuries the only real safe-haven assets, while affecting negatively the status of safe haven for longer-term securities.”

Market participants consider short-term and long-term debt to be different types of safe-haven assets. Treasury bills serve as cash-like assets for the short run, while investors wait for the prevailing uncertainty to be resolved. Long-term Treasuries, conversely, are favored when concerns about the prospects for long-term economic growth exist.

Volatility in long-term Treasury rates increases the incidence of flights and is an “omen of pervasive market instability.” Such volatility often reflects variations in uncertainty about the macroeconomic environment more so than short-term benchmarks do.

Moreover, flights into Treasury bills respond to the performance of short-term, but not long-term, Treasuries and high-grade corporate bonds. Corporate bonds, however, respond to the dismal performance of long-term Treasuries.

In reaching their conclusions, the authors looked at contiguous benchmark and crisis periods of two months and one month, respectively. They studied the period of 1990 through 2014, rolling over each period by one day. A change in the status quo was sought, which allowed for the benchmark period to have been marked by volatility. Doing so allowed flights to be identified with respect to then-prevailing conditions instead of a perceived “normal” market environment.

Source: “Flights From Stocks,” Ning Cao and Valentina Galvani, SSRN, May 27, 2016.

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