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Shadow leverage risk and corporate bond pricing: evidence from China

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  • Xu Feng
  • Lin Huang
  • Guanying Wang

Abstract

This study investigates the effect of shadow bank leverage on corporate bond returns. Using a unique dataset of Wealth Management Products (WMPs), we construct a new measurement of shadow leverage in the Chinese banking system. We find that the sensitivity of bond returns to the risk of shadow leverage has a negative effect on corporate bond returns. We propose a new three-factor bond pricing model by adding the factor of shadow leverage risk into the traditional two-factor model of Fama and French (1993. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics 33: 3–56). A comprehensive empirical analysis shows that the proposed model fits corporate bond returns well and outperforms the two-factor bond pricing model, both in- and out-of-samples. Specifically, the shadow leverage risk factor makes greater marginal contributions in lower credit rating groups and more shadow leverage-sensitive groups. Overall, we highlight the importance of shadow banks in the role of asset pricing.

Suggested Citation

  • Xu Feng & Lin Huang & Guanying Wang, 2021. "Shadow leverage risk and corporate bond pricing: evidence from China," The European Journal of Finance, Taylor & Francis Journals, vol. 27(18), pages 1834-1854, December.
    • Handle: RePEc:taf:eurjfi:v:27:y:2021:i:18:p:1834-1854
    DOI: 10.1080/1351847X.2021.1923548
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    Cited by:

    1. Deng, Chao & Su, Xiaojian & Wang, Gangjin & Peng, Cheng, 2022. "The existence of flight-to-quality under extreme conditions: Evidence from a nonlinear perspective in Chinese stocks and bonds' sectors," Economic Modelling, Elsevier, vol. 113(C).

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