Understanding the Comovement between Corporate Bonds and Stocks: The Role of Default Risk

85 Pages Posted: 6 Jul 2022

See all articles by Alexander Dickerson

Alexander Dickerson

Warwick Business School

Mathieu Fournier

UNSW Business School

Alexandre Jeanneret

UNSW Business School

Philippe Mueller

Warwick Business School Finance Group

Date Written: June 16, 2022

Abstract

We show that firm default risk is the primary predictor of the comovement between corporate bond and stock returns, both in the cross-section and over time. Intuitively, bonds of less creditworthy firms behave more like the issuing firms’ stocks, resulting in higher future comovement. We find that investing in bonds and stocks of the most creditworthy firms significantly enhances diversification benefits and Sharpe ratios out-of-sample. We develop a structural model with stochastic asset variance that rationalizes these findings. The model is consistent with salient asset pricing and default risk moments and contributes to understanding the forces driving stock-bond comovement.

Keywords: Corporate bonds, stock-bond comovement, default risk, structural model, asset pricing

JEL Classification: G12, G13

Suggested Citation

Dickerson, Alexander and Fournier, Mathieu and Jeanneret, Alexandre and Mueller, Philippe, Understanding the Comovement between Corporate Bonds and Stocks: The Role of Default Risk (June 16, 2022). WBS Finance Group Research Paper Forthcoming, UNSW Business School Research Paper Forthcoming, Available at SSRN: https://ssrn.com/abstract=4138544 or http://dx.doi.org/10.2139/ssrn.4138544

Alexander Dickerson (Contact Author)

Warwick Business School ( email )

University of Warwick
Coventry, Warwickshire CV4 7ES
United Kingdom

Mathieu Fournier

UNSW Business School ( email )

UNSW Business School
High St
Sydney, NSW 2052
Australia

Alexandre Jeanneret

UNSW Business School ( email )

Sydney, NSW 2052
Australia

Philippe Mueller

Warwick Business School Finance Group ( email )

Gibbet Hill Rd
Coventry, CV4 7AL
Great Britain

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