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Takeover risk and the correlation between stocks and bonds

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  • Bhanot, Karan
  • Mansi, Sattar A.
  • Wald, John K.
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    Abstract

    Existing research suggests that, for a given firm, stock returns and bond prices are positively related, and this implies a negative relation between stock returns and bond spreads. In this paper, we show how takeover risk influences this relation. Bondholders of high-rated firms can suffer losses in a takeover, particularly if the takeover is largely funded with debt, resulting in a more positive (or less negative) correlation between stock returns and bond spread changes. Consistent with this notion and based on a large sample of data covering the period from 1980 to 2000, we find that high-rated firms which are likely to be taken over have a more positive correlation between stock returns and bond spread changes, while target firms with a poison put or an indebtedness covenant have a more negative correlation. Overall, our findings have implications for the pricing and hedging of bonds and default risk based financial products such as credit default swaps.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Empirical Finance.

    Volume (Year): 17 (2010)
    Issue (Month): 3 (June)
    Pages: 381-393

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    Handle: RePEc:eee:empfin:v:17:y:2010:i:3:p:381-393

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    Web page: http://www.elsevier.com/locate/jempfin

    Related research

    Keywords: Stock-bond correlation Takeover probability Debt covenants;

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