European Finance Association
Milan, Italy | August 25-27, 2021
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APE 06: The cross-section of corporate bond returns
Book-to-Market, Mispricing, and the Cross-Section of Corporate Bond Returns
1University of Warwick and CEPR, United Kingdom; 2UCLA Anderson and NBER; 3Hong Kong University of Science and Technology
We study the role played by “bond book-to-market” ratios in U.S. corporate bond pricing. Controlling for numerous risk factors tied to default and priced asset risk, including yield-to-maturity, we find that the ratio of a corporate bond’s book value to its market price strongly predicts the bond’s future return. The quintile of bonds with the highest bond book-to-market ratios outperforms the quintile with the lowest ratios by more than 3% per year, other things equal. Additional evidence on signal delay, scope of signal efficacy, and factor risk rejects the thesis that the corporate bond market is perfectly informationally efficient.
Switching Perspective: How Does Firm-Level Distress Risk Price the Cross-Section of Corporate Bond Returns?
1PBC School of Finance, Tsinghua University; 2Alliance Manchester Business School, University of Manchester
We document a significantly negative relation between firm-level distress risk and the cross-section of corporate bond returns, analogous to the often negative relation between distress risk and stock returns in the prior literature ("distress anomaly"). Our evidence casts doubts on theories attributing the distress anomaly to shareholders exploiting debtholders in distress ("shareholder advantage"). In accordance, shareholder advantage proxies do not condition the distress risk-bond return relation. Conversely, we show that real options theories with disinvestment also have the potential to explain the anomaly, with disinvestment proxies conditioning the relation between distress risk and both stock and bond returns.
The Core, the Periphery, and the Disaster: Corporate-Sovereign Nexus in COVID-19 Times
1Leibniz Institute for Financial Research SAFE and Goethe University Frankfurt; 2Ca' Foscari University of Venice; 3CEPR; 4Università della Svizzera Italiana; 5Swiss Finance Institute
We study how the COVID-19 pandemic reshaped the relation between corporate and sovereign credit risk in the cross-section of countries in the European Union. Surprisingly, the outbreak triggered higher elasticity of corporate to sovereign CDS spreads in core countries, which realigned to that of peripheral countries, with lower fiscal capacity, for which the impact of the pandemic on the elasticity was essentially muted. During the pandemic, we observe systematic departures of actual CDS from those implied by a standard structural model of default for larger firms in core EU countries with budgetary slackness. We interpret this evidence in light of a disaster-risk asset pricing model with bailout guarantees and defaultable public debt. Based on the model and a synthetic control method, we show that CDS-implied risk-adjusted bailout guarantees over the medium term were about three times larger in the Core than in the Periphery.
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