Stock and Bond Market Interaction: Does Momentum Spill Over?

Abstract

This paper examines the interaction between momentum in equities and corporate bonds. We find that investment grade corporate bonds do not exhibit momentum at the three to twelve month horizons; rather there is evidence of reversals. There is, however, significant evidence of a momentum spillover from equities to investment grade corporate bonds of the same firm. Specifically, firms earning high (low) equity returns over the previous year earn high (low) bond returns the following year. The spillover results are stronger among firms with lower-grade debt and higher equity trading volume, and are robust to various risk and liquidity controls. In examining the source of the spillover, we find that the bond ratings of firms with positive equity momentum continue to improve in the future suggesting that delayed reaction to the information in past equity prices about declining default risk is a likely source of the spillover effect.

JEL Classification: G14