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Endogenous inattention and risk-specific price underreaction in corporate bonds

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  • Li, Jiacui

Abstract

Corporate bond prices are slow to respond to default risk and interest rate shocks, as proxied by firm-level stock returns and Treasury returns, respectively. Furthermore, the underreaction is risk-specific: bonds with better credit quality underreact more to default risk, while those with worse quality underreact more to interest rates. The underreactions imply substantial out-of-sample return predictability, and investors appear to be leaving too much money on the table. The results are consistent with behavioral inattention models in which investors endogenously allocate more attention to payoff-relevant (or salient) risks, and they are not explained by traditional trading friction mechanisms.

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  • Li, Jiacui, 2022. "Endogenous inattention and risk-specific price underreaction in corporate bonds," Journal of Financial Economics, Elsevier, vol. 145(2), pages 595-615.
    • Handle: RePEc:eee:jfinec:v:145:y:2022:i:2:p:595-615
    DOI: 10.1016/j.jfineco.2021.09.025
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    More about this item

    Keywords

    Investor inattention; Rational inattention; Price underreaction; Corporate bonds; Credit risk;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets

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