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Investor sentiment, flight-to-quality, and corporate bond comovement

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  • Bethke, Sebastian
  • Gehde-Trapp, Monika
  • Kempf, Alexander

Abstract

We examine the dynamics of bond correlation using a broad sample of US corporate bonds, and document that bond correlation varies heavily over time. We attribute this variation in bond correlation to variation in risk factor correlation reflecting time-varying flight-to-quality behavior of investors. We show that risk factor correlation increases when investor sentiment worsens, i.e., corporate bond investors exhibit stronger flight-to-quality when their sentiment is bad. Thus, bad investor sentiment leads to flight-to-quality behavior and, ultimately, high bond correlation. Very good sentiment, in contrast, can cause risk factor correlation and bond correlation to be negative.

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  • Bethke, Sebastian & Gehde-Trapp, Monika & Kempf, Alexander, 2017. "Investor sentiment, flight-to-quality, and corporate bond comovement," Journal of Banking & Finance, Elsevier, vol. 82(C), pages 112-132.
  • Handle: RePEc:eee:jbfina:v:82:y:2017:i:c:p:112-132
    DOI: 10.1016/j.jbankfin.2017.02.007
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    1. repec:eee:jrpoli:v:53:y:2017:i:c:p:208-218 is not listed on IDEAS
    2. repec:eee:finmar:v:38:y:2018:i:c:p:60-82 is not listed on IDEAS

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    Keywords

    Bond correlation; Risk factor correlation; Flight-to-quality; Investor sentiment;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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