Economic Links from Bonds and Cross-Stock Return Predictability
83 Pages Posted: 28 Mar 2022 Last revised: 6 Nov 2023
Date Written: March 2, 2022
Abstract
Identifying firms’ bond-market-specific economic links through credit-rating comovement of their corporate bonds, a long-short strategy for stocks based on these links generates a risk-adjusted alpha of 0.45% per month, which cannot be explained by existing economic links in the literature. Market segmentation between the equity and bond markets appears to be the underlying mechanism: (i) The cross-return predictability is muted in the bond market; (ii) The cross-return predictability is mitigated in the presence of cross-holding investors; (iii) Equity analysts slowly incorporate information from rating-comovement links to their forecasts.
Keywords: Economic linkage, cross-firm return predictability, credit-rating comovement, market segmentation, market inefficiency
JEL Classification: G12, G14, G23, G24
Suggested Citation: Suggested Citation