Endogenous Inattention and Risk-Specific Price Underreaction in Corporate Bonds

45 Pages Posted: 3 Oct 2017 Last revised: 30 Aug 2021

See all articles by Jiacui Li

Jiacui Li

David Eccles School of Business, University of Utah

Date Written: November 16, 2018

Abstract

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. Furthermore, the underreaction is risk-specific: bonds with better credit quality underreact more to default risk, while those with worse quality underreact more to interest rates. The underreactions 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 are not explained by traditional trading friction mechanisms.

Keywords: Investor inattention, endogenous inattention, rational inattention, price underreaction, corporate bonds

JEL Classification: G12, G14, G41

Suggested Citation

Li, Jiacui, Endogenous Inattention and Risk-Specific Price Underreaction in Corporate Bonds (November 16, 2018). Journal of Financial Economics (JFE), Forthcoming, Available at SSRN: https://ssrn.com/abstract=3046870 or http://dx.doi.org/10.2139/ssrn.3046870

Jiacui Li (Contact Author)

David Eccles School of Business, University of Utah ( email )

HOME PAGE: http://https://www.jiacui-li.com/

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