Endogenous Investor Inattention and Price Underreaction to Information
42 Pages Posted: 3 Oct 2017 Last revised: 26 Apr 2021
Date Written: November 16, 2018
I find that corporate bond prices are slow to respond to default risk and interest rate shocks, as proxied by firm-level stock returns and Treasury returns, respectively. The underreaction is risk-specific: bonds with better credit quality underreact more to de- fault risk while those with worse quality underreact more to interest rates. The under- reactions imply substantial out-of-sample return predictability, and investors appear to be leaving too much money on the table. The results are consistent with behavioral inattention models in which investors endogenously allocate more attention to payoff- relevant (or salient) risks, and they cannot be explained by traditional trading friction mechanisms.
Keywords: Investor inattention, endogenous inattention, price underreaction, corporate bonds
JEL Classification: G12, G14, G41
Suggested Citation: Suggested Citation