Excess Volatility of Corporate Bonds
Ohio State University (OSU) - Department of Finance
Massachusetts Institute of Technology (MIT) - Economics, Finance, Accounting (EFA); National Bureau of Economic Research (NBER); China Academy of Financial Research (CAFR)
October 4, 2010
AFA 2009 San Francisco Meetings Paper
Charles A. Dice Center Working Paper No. 2010-20; Fisher College of Business Working Paper No. 2010-03-020
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.
Number of Pages in PDF File: 41working papers series
Date posted: March 13, 2008 ; Last revised: October 15, 2010
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