How Integrated Are Corporate Bond and Stock Markets?

Abstract

I propose a model-free measure of the extent of relative market integration between U.S.
corporate bonds and stocks of their issuers. My measure is both consistent with no-arbitrage
and financial frictions, and quantifies pricing consistency across markets. I document that
trading frictions, often imposed on market participants, including transaction costs and short-selling
constraints, yield realistic optimal portfolio positions. Overall, my evidence indicates
U.S. stock and corporate bond markets are non-trivially integrated, by an extent between 50%
and 90% of a model-free full-integration benchmark, depending on the severity of financial
frictions, firm characteristics, and the risk-bearing capacity of financial intermediaries.

Keywords: stochastic discount factor, corporate bonds, stocks, market integration, firm characteristics.

JEL Classification: G11, G12, G14