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Excess Volatility of Corporate Bonds

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  • Bao, Jack

    (Ohio State University)

  • Pan, Jun

Abstract

This paper examines the connection between the return volatilities of corporate bonds, equities, and Treasuries under the Merton model with stochastic interest rates. Constructing empirical volatilities using bond returns over daily, weekly, and monthly horizons, we find that empirical bond volatilities are too high to be explained by equity and Treasury volatilities. Furthermore, the results are robust to using credit default swaps rather than corporate bonds to measure volatility in the credit market. At the daily return horizon, the excess volatility of corporate bonds is related to known liquidity proxies. However, this relation disappears at the monthly horizon even though corporate bonds continue to be excessively volatile. Thus, there appears to be a disconnect between corporate bonds and equities that goes beyond the illiquidity of corporate bonds.

Suggested Citation

  • Bao, Jack & Pan, Jun, 2010. "Excess Volatility of Corporate Bonds," Working Paper Series 2010-20, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    • Handle: RePEc:ecl:ohidic:2010-20
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    File URL: http://www.cob.ohio-state.edu/fin/dice/papers/2010/2010-20.pdf
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    Cited by:

    1. Asquith, Paul & Au, Andrea S. & Covert, Thomas & Pathak, Parag A., 2013. "The market for borrowing corporate bonds," Journal of Financial Economics, Elsevier, vol. 107(1), pages 155-182.
    2. Barsotti, Flavia & Viva, Luca Del, 2015. "Performance and determinants of the Merton structural model: Evidence from hedging coefficients," Journal of Banking & Finance, Elsevier, vol. 58(C), pages 95-111.

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