What Does the Corporate Bond Market Know?

Date01 February 2014
Published date01 February 2014
The Financial Review 49 (2014) 1–19
What Does the Corporate Bond
Market Know?
George Bittlingmayer
The University of Kansas
Shane M. Moser
The University of Mississippi
Do related markets reflect new information simultaneously? For high-yield bonds, a large
abnormal price decline in a corporation’s most liquid bond over a month is followed by an
average abnormal stock price decline of 1.42%. This effect is larger for stocks that have
increased in value and for volatile stocks. It is also larger for bonds with high coupons and
shorter maturities. These results support the view that high-yield corporate bonds have an
informational edge when news is negative and stock returns are noisy, and add to the growing
literature on the substantial lags in price discovery between related markets.
Keywords: corporate bonds, informational efficiency, market liquidity
JEL Classifications: G12, G14
Corresponding author: University of Kansas School of Business, 1300 Sunnyside Avenue, Lawrence,
KS 66045; Phone: (785) 864-7541; Fax: (785) 864-5328; E-mail: bittlingmayer@ku.edu.
We thank the editor, Robert Van Ness, two anonymous referees, Jean Helwege, Andre Liebenberg, and
Andy Puckett, Catherine Shenoy,Kelly Welch, and seminar participants at the 2008 FMA Conference, the
2008 CRSP Forum, and the University of Kansas for their comments and suggestions.
C2014 The Eastern Finance Association 1
2G. Bittlingmayer and S. M. Moser/The Financial Review 49 (2014) 1–19
1. Introduction
Do related markets incorporate new information at the same time? And, if one
market leads, how long does it take for the other market to follow? Recent research
suggests that less liquid markets, including debt markets, may in fact be venues for
informed trading. Other work suggests that the incorporation of information across
related markets may take several weeks or longer.
We investigate whether a corporation’s bonds anticipate changes in its stock
price, and whether they do so at monthly intervals. This seems implausible at first
glance. Corporate bond trading is notoriously spotty, illiquid, and confined to less
transparent over-the-counter (OTC) markets. In fact, the early research on bond–
stock interaction finds that a corporation’s bonds are less efficiently priced and lag
its stock price (Kwan, 1996; Hotchkiss and Ronen, 2002; Gebhardt, Hvidkjaer and
Swaminathan, 2005).
There are several reasons to take a new look. First, a growing body of literature
finds that equity markets may not reflect all available information immediately be-
cause some information spreads slowly, because investors specialize in certain types
of information, because investors are distracted by other events, or because investor
sentiment and constraints on short selling prevent immediate adjustment. Second,
and perhaps surprisingly, it appears that equity markets may react to newinformation
with a lag of a month or more. (The literature on bond–stock market interactions
focuses on shorter intervals.) Third, the advent of the Trade Reporting and Compli-
ance Engine (TRACE) in 2002 has increased the quality of bond market data, our
understanding of bond market dynamics, and, quite possibly, the efficiency of the
bond market itself. Taken together, these developments provide reason for taking a
new look at the circumstances under which bonds lead stocks, particularly at monthly
Our work examines the ability of a company’s most liquid bond to predict what
will happen to its stock by using TRACE bond trade data for 675 firms for the period
July 2002 through December 2008. After adjusting both stock and bond returns for
relevant market movements, we regress monthly stock returns on lagged bond and
lagged stock returns to assess whether past bond price movements anticipate stock
price movements. For high-yield bonds, it turns out that they do. For this group,
being in the bottom decile of abnormal bond returns in month t1 is associated
with a 1.42% abnormal stock decline in month t. This effect is stronger among
firms with volatile stock, firms with large prior abnormal stock returns, high coupon
bonds, and cases where a firm’s most liquid bond has a shorter maturity. There is
also appreciable evidence of an asymmetric effect, with bond price declines having
a larger cross-momentum effect than bond price increases. In contrast to our results
1In addition, increased trading in credit default swaps (CDS) written on corporate bonds may affect bond
market efficiency.Asquith, Au, Covert and Pathak (2013) report that bonds with CDS contracts are more
actively lent.

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