Prices and Volatilities in the Corporate Bond Market

Fisher College of Business Working Paper No. 2015-03-18

Charles A. Dice Center Working Paper No. 2015-18

63 Pages Posted: 29 Aug 2015

See all articles by Jack Bao

Jack Bao

University of Delaware - Department of Finance

Jia Chen

Peking University - Guanghua School of Management

Kewei Hou

Ohio State University (OSU) - Department of Finance

Lei Lu

Peking University - Guanghua School of Management

Date Written: August 27, 2015

Abstract

We document a strong positive cross-sectional relation between corporate bond yield spreads and bond return volatilities. As corporate bond prices are generally attributable to both credit risk and illiquidity as discussed in Huang and Huang (2012), we apply a decomposition methodology to quantify the relative contributions of credit and illiquidity. Overall, our credit and illiquidity proxies can explain almost three quarters of the yield spread-bond volatility relation with credit and illiquidity contributing in a 70:30 ratio. Furthermore, we find that the credit portion of the yield spread-bond volatility relation is important even after controlling for equity volatility. The relation between yield spreads and volatilities is robust to different sample periods, including the financial crisis. We also find the ratio to be smaller for the investment-grade sub-sample, consistent with credit risk being relatively more important for understanding the yield spread-volatility relation in speculative-grade bonds.

Keywords: Bond volatility, Yield spreads, Credit risk, Illiquidity, Decomposition

JEL Classification: G11, G12, G13

Suggested Citation

Bao, Jack and Chen, Jia and Hou, Kewei and Lu, Lei, Prices and Volatilities in the Corporate Bond Market (August 27, 2015). Fisher College of Business Working Paper No. 2015-03-18. Available at SSRN: https://ssrn.com/abstract=2651243 or http://dx.doi.org/10.2139/ssrn.2651243

Jack Bao

University of Delaware - Department of Finance ( email )

Alfred Lerner College of Business and Economics
Newark, DE 19716
United States

Jia Chen

Peking University - Guanghua School of Management ( email )

Peking University
Beijing, Beijing 100871
China

Kewei Hou (Contact Author)

Ohio State University (OSU) - Department of Finance ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States
614-292-0552 (Phone)
614-292-2418 (Fax)

Lei Lu

Peking University - Guanghua School of Management ( email )

Peking University
Beijing, Beijing 100871
China

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