Is the Corporate Bond Market Forward Looking?
38 Pages Posted: 18 Aug 2007
Date Written: August 2007
This paper presents empirical evidence that the corporate bond market is forward looking with respect to volatility. I use the Merton (1974) model to calculate a measure of implied volatility from corporate bond yield spreads. I find that corporate bond transaction prices contain substantial information about future volatility: When predicting future volatility in a regression model, implied volatility comes in significantly and increases the R(sq) when added to historical volatility. Consistent with this finding, single stock option implied volatility helps explain the variation in bond yield spreads when included together with historical volatility.
Keywords: corporate bond spreads, Merton model, implied volatility, equity volatility, bond pricing
JEL Classification: G12, G13
Suggested Citation: Suggested Citation