Sentiment and Corporate Bond Valuations Before and After the Onset of the Credit Crisis
Posted: 26 Jul 2013 Last revised: 22 May 2019
Date Written: January 12, 2015
This paper studies how stock market sentiment impacts corporate bond valuations. Using bond transactions from the Trading and Compliance Engine (TRACE), we find that sentiment is negatively related to bond yield spreads, with the impact being stronger after the onset of the recent credit crisis. After the crisis, the variation in sentiment also helps explain the extent to which the corporate bond market and the equity market are integrated. Our conditional analysis reveals that the negative effect of sentiment on yields is stronger when fundamental risk and liquidity frictions are higher pointing to a direct role of sentiment in the bond market whereby rational bond investors are unable in these high risk/high frictions scenarios to correct the mispricing generated by other bond investors. We also find that the sentiment effect is stronger when the returns to capital structure arbitrage are higher, suggesting that sentiment also spills over to the bond market through the activity of investors dedicated to correcting relative stock and bond value mispricings within the same firm.
Keywords: sentiment, credit crisis, equity/bond market integration
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