Implied Volatility Changes and Corporate Bond Returns

Abstract

Corporate bonds with large increases in implied volatility over the past month underperform those with large decreases in implied volatility by 0.6% per month. In contrast to An, Ang, Bali, and Cakici (2014) who show that implied volatility changes carry information about fundamental news, our evidence suggests that implied volatility changes contain information about uncertainty shocks to the firm. Our results are consistent with the notion that informed traders with new information about firm risk prefer to trade in the option market, and that the corporate bond market under-reacts to this information.

Keywords: Corporate bonds, implied volatility changes, default risk, information diffusion

JEL Classification: G10, G12, G14