Anomalies and Market (Dis)Integration

Abstract

If equity and corporate bond markets are integrated, risk premia in one market should appear in the other, and their magnitudes should be consistent with each other. We use this insight to examine market integration between equity and corporate bonds in the cross section. Some variables (e.g., profitability and net issuance) that explain equity returns do not explain bond returns, and for others (e.g., investment and momentum) cross-sectional bond returns are too large to be explained by their loadings, or hedge ratios, on equity returns of the same firms. The risk premia of the standard factors estimated using bond returns tend to differ from those estimated using equity returns. We also find that discrepancies in return premia increase when noisy investor demand and short-sale impediments are stronger.

Keywords: Market Integration, Cross-sectional Returns, Corporate Bonds, Investor Sentiment