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Comovement of Corporate Bonds and Equities

  • Bao, Jack

    (OH State University)

  • Hou, Kewei

    (OH State University)

We study heterogeneity in the comovement of corporate bonds and equities, both at the bond level and at the firm level. Using an extended Merton model, we illustrate that corporate bonds that mature late relative to the rest of the bonds in its issuer's maturity structure should have stronger comovement with equities. In contrast, endogenous default models suggest that a bond's position in its issuer's maturity structure has little relation with the strength of the comovement between bonds and equities. Empirically, we find results consistent with the prediction of the extended Merton model. In addition, we find that comovement between bonds and equities is stronger for firms with higher credit risk as proxied by the book-to-market ratio and distance-to-default even after controlling for ratings. Our evidence suggests that market participants are able to assess credit quality at a more granular level than ratings.

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Paper provided by Ohio State University, Charles A. Dice Center for Research in Financial Economics in its series Working Paper Series with number 2013-11.

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Date of creation: Jul 2013
Date of revision:
Handle: RePEc:ecl:ohidic:2013-11
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