How Integrated Are Corporate Bond and Stock Markets?
41 Pages Posted: 25 Feb 2020 Last revised: 18 Nov 2020
Date Written: November 1, 2019
I study the degree of market integration between U.S. corporate bonds and stocks of their issuers. I document that trading costs and short-selling constraints, which are often imposed on market participants, regularize optimal Sharpe ratio portfolios. These novel trading frictions are consistent with a notion of no-arbitrage with transaction costs. I use a nonparametric approach to circumvent the joint hypothesis test of model specification and market integration. My empirical findings suggest that stocks co-move more strongly with stock-like corporate bonds, especially those of small, growth firms, with lower profitability, liquidity, asset growth, and with higher credit riskiness, leverage and demand for short-selling. Overall, my evidence indicates U.S. stock and corporate bond markets are non-trivially integrated, yet not perfectly so, and especially when the risk-bearing capacity of financial intermediaries is more impaired.
Keywords: stochastic discount factor, corporate bonds, stocks, market integration, firm characteristics.
JEL Classification: G11, G12, G14
Suggested Citation: Suggested Citation