Bonds vs. Equities: Information for Investment
47 Pages Posted: 10 May 2021
Date Written: April 15, 2021
We provide robust empirical evidence that uncovers the reason for the observed closer relationship between the bond market versus the equity market and the macroeconomy. Our results indicate that the tight bond market-macroeconomy link is not due to differences in the investor base, but instead to the unique transformations of asset volatility and leverage that credit spreads and equity volatility represent. We focus on the investment channel. Using firm-level data, we find that the sensitivity of investment to equity volatility is highly significant, but changes sign in the cross section of firms depending on their distance to default. This sign change confounds aggregate inference. We rationalize these findings using a simple structural model of credit risk and investment with debt overhang.
Keywords: Volatility, Credit Spread, Leverage, Debt Overhang, Investment
JEL Classification: E22, E44, G12, G32
Suggested Citation: Suggested Citation