Sentiment and Corporate Bond Valuations Before and After the Onset of the Credit Crisis
Pennsylvania State University - University Park - Department of Finance
Texas A&M; University of Notre Dame - Department of Finance
John Molson School of Business, Concordia University
September 20, 2014
Stock market sentiment is an important driver of corporate bond valuations. Using transactions from the Trading and Compliance Engine (TRACE), we find that sentiment is negatively related to bond yield spreads, with the impact being stronger after the onset of the recent financial crisis. The negative effect of sentiment on yields is stronger when fundamental risk and liquidity frictions are higher, which points to a direct role of sentiment in the bond market whereby rational bond investors are unable in these high risk/high frictions scenarios to correct the mispricing generated by other bond investors. We also find that the sentiment effect is stronger when the returns to capital structure arbitrage are higher, suggesting that sentiment also spills over to the bond market through the activity of investors dedicated to correcting relative stock and bond value mispricings within the same rm. Additionally, we provide evidence that after the onset of the crisis, sentiment also helps explain the extent to which the corporate bond market and the equity market are integrated.
Number of Pages in PDF File: 41
Keywords: sentiment, credit crisis, equity/bond market integrationworking papers series
Date posted: July 26, 2013 ; Last revised: September 23, 2014
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