Corporate Stock and Bond Return Correlations and Dynamic Adjustments of Capital Structure

42 Pages Posted: 17 Jul 2015

See all articles by Belen Nieto

Belen Nieto

University of Alicante

Rosa Rodríguez

Universidad Carlos III de Madrid - Department of Business Administration

Date Written: June/July 2015

Abstract

This paper analyses the effects of dynamic correlations between stock and bond returns issued by the same firm on the speed of adjustment towards target leverage. The results show that the estimated correlations are time varying, show persistence and differ among firms. Analysis of the potential explanatory variables reveals that the correlations decrease with negative expectations about future aggregate risks, but only for firms with a low default probability. In contrast, correlations are positively associated with specific risk measures, especially idiosyncratic stock risk and financial leverage. The positive relationship between the correlations and the leverage ratio suggests that target leverage can be achieved faster when the stock–bond correlation is high. Our results show that this is the case.

Keywords: individual stock‐bond correlation, leverage, idiosyncratic risk, economic cycles, speed of adjustment, target capital structure

Suggested Citation

Nieto, Belen and Rodriguez, Rosa, Corporate Stock and Bond Return Correlations and Dynamic Adjustments of Capital Structure (June/July 2015). Journal of Business Finance & Accounting, Vol. 42, Issue 5-6, pp. 705-746, 2015. Available at SSRN: https://ssrn.com/abstract=2631839 or http://dx.doi.org/10.1111/jbfa.12114

Belen Nieto (Contact Author)

University of Alicante ( email )

Campus de San Vicente
Carretera San Vicente del Raspeig
San Vicente del Raspeig, Alicante 03690
Spain

Rosa Rodriguez

Universidad Carlos III de Madrid - Department of Business Administration ( email )

Calle Madrid 126
Getafe, Madrid, Madrid 28903
Spain

HOME PAGE: http://www.business.uc3m.es/en/faculty/profesor/perfil/42

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