Bonds, Stocks, and Sources of Mispricing

This paper shows that distressed stocks and bonds are overpriced during high sentiment periods. The correction of overpricing leads to a range of anomalous cross-sectional patterns in stock and bond returns. Including bonds as additional test assets allows us to develop testable restrictions about overpricing rationales related to lottery-type preferences, shareholders' ability to extract value during bankruptcy, and market sentiment. It also reinforces the notion that anomaly payoffs are unexplained by co-movement with risk factors. The evidence suggests that anomalies are attributable to sentiment-driven investors' (both retail and institutional) excessive optimism about the likelihood and consequences of financial distress.

Keywords: sentiment, mispricing, anomalies, bonds, stocks, financial distress

JEL Classification: G12, G14

Suggested Citation: Suggested Citation

Avramov, Doron and Chordia, Tarun and Jostova, Gergana and Philipov, Alexander, Bonds, Stocks, and Sources of Mispricing (March 27, 2019). George Mason University School of Business Research Paper No. 18-5, Available at SSRN: https://ssrn.com/abstract=3063424 or http://dx.doi.org/10.2139/ssrn.3063424