Stock‐Bond Return Co‐Movement and Accounting Information

37 Pages Posted: 3 Aug 2017

Multiple version iconThere are 2 versions of this paper

Date Written: July/August 2017

Abstract

I examine how an important attribute of financial reporting quality, i.e., accounting conservatism, affects the sensitivity of corporate bond returns to changes in the value of equity (i.e., the hedge ratio). The correlation between stock and bond returns (co‐movement) is a fundamental input for asset allocation decisions as it determines the diversification benefits of bonds relative to equities within an investment portfolio. According to structural models of credit risk, co‐movement should be generally positive, but lower when the risk of wealth transfers from bondholders to shareholders is severe. I find that firms that report conservative earnings and use covenants in their bond contracts exhibit on average stronger co‐movement. This result is consistent with conservatism providing bondholders with a credible and contractible signal that improves monitoring, thus preventing wealth transfers.

Keywords: stock‐bond correlation, co‐movement, asset allocation, hedge ratios, credit risk, wealth transfers, accounting conservatism, debt covenants

Suggested Citation

Cascino, Stefano, Stock‐Bond Return Co‐Movement and Accounting Information (July/August 2017). Journal of Business Finance & Accounting, Vol. 44, Issue 7-8, pp. 1036-1072, 2017, Available at SSRN: https://ssrn.com/abstract=3012792 or http://dx.doi.org/10.1111/jbfa.12253

Stefano Cascino (Contact Author)

London School of Economics ( email )

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