Corporate Bond Returns and the Financial Crisis
Posted: 14 Mar 2012 Last revised: 23 Aug 2014
Date Written: January 1, 2012
We assess the impact of the recent financial crisis and government interventions to ameliorate the ensuing recession on corporate bond returns through the lens of bond market reactions to news conveyed by changes in aggregate earnings as a proxy for changes in expected future cash flows and changes in T-Bill rates as a proxy for changes in expected future discount rates. The association of T-Bill rate changes with bond returns is negative as expected prior to the financial crisis, but shifts to positive with the onset of the crisis partly explainable by government bailouts of large banks, and flight to safety for bonds issued by other institutions. The association of earnings changes with bond returns is positive as expected prior to the crisis, but, while remaining positive for investment grade, becomes insignificant for speculative grade bonds. The absence of an effect for investment grade bonds we attribute timely loss recognition in earnings by financial institutions subject to immediate loss recognition under mark-to-market accounting and profits during recovery as government relief took effect. The latter shift to insignificance we attribute to earnings changes reflecting diminished earnings persistence and delayed recognition of losses by non-financial institutions. Generally speaking, our results suggest that government intervention during the crisis period had significant effects on corporate bond markets. We also observe that earnings changes as a source of cash flow news is sensitive to the accounting policies that come to bear. More broadly, further results suggest that relations between bond returns and news conveyed by earnings and T-Bill rate changes are sensitive to the business cycle.
Keywords: Corporate Bond Returns, Aggregate Earnings, Returns Decomposition, Financial Crisis, Government Relief
Suggested Citation: Suggested Citation