Informed Bond Trading, Corporate Yield Spreads, and Corporate Default Prediction

34 Pages Posted: 20 Mar 2011 Last revised: 27 Apr 2013

See all articles by Song Han

Song Han

Board of Governors of the Federal Reserve System

Xing (Alex) Zhou

Board of Governors of the Federal Reserve System

Date Written: April 15, 2013

Abstract

Taking advantage of recently augmented corporate bond transaction data, we examine the pricing implications of informed trading in corporate bonds and its ability to predict corporate defaults. We find that microstructure measures of information asymmetry seem to capture adverse selection in corporate bond trading reasonably well. We demonstrate that information asymmetry in bond trading has explanatory power for corporate bond yield spreads, and this result holds after controlling for the transaction costs of liquidity, credit risk, and other traditional bond pricing factors. Further, information asymmetry can help forecast corporate defaults after conditioning on other default prediction variables. Such forecasting ability of bond informed trading is especially useful for private firms as the bond market constitutes the only venue for informed traders to exploit their information advantages.

Keywords: Corporate Bond Yield Spreads, Information Asymmetry, Information Risk Premium, Credit Risk, Corporate Default Prediction

JEL Classification: G12, G14

Suggested Citation

Han, Song and Zhou, Xing (Alex), Informed Bond Trading, Corporate Yield Spreads, and Corporate Default Prediction (April 15, 2013). Available at SSRN: https://ssrn.com/abstract=1786787 or http://dx.doi.org/10.2139/ssrn.1786787

Song Han (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States
202-736-1971 (Phone)
202-452-3891 (Fax)

Xing (Alex) Zhou

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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