Information Transmission in Stock and Bond Markets

Abstract

Using a comprehensive dataset covering all U.S. corporate bonds, we study the lead-lag relationship between bond and stock returns. Our analysis documents a robust predictive relationship, where a firm’s bond returns predict its future stock returns. This finding is stronger for firms with low credit ratings, reflecting the importance of information about default. Additionally, we find that the presence of active and informed trading in bonds enhances this cross-market predictability, highlighting the stock market’s slow adjustment to information in bonds. Analysis around earnings announcements suggests that the information conveyed relates to firm cash flows rather than risk premia.

Keywords: Market efficiency, information transmission, bond-stock cross-market relation, stock return predictability JEL Classification: G14

JEL Classification: G14