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Who poisons the pool? Time-varying asymmetric and nonlinear causal inference between low-risk and high-risk bonds markets

Geoffrey M. Ngene, Yea Lee Kim and Jinghua Wang

Economic Modelling, 2019, vol. 81, issue C, 136-147

Abstract: Corporate bond markets enable the efficient allocation of capital among competing firms, as well as an extensive degree of disintermediation. While the role of the junk bond market in financing leveraged buyouts, “fallen angels,” start-ups, small firms, and sovereign governments is known, little is known about interactions between low-risk (AAA) bonds markets and high-risk (CCC and below) bonds markets. In this study, we used a sample of daily data spanning 20 years to investigate the dynamic link in first and second moments between low-risk and high-risk bonds during calm and turbulent periods in the U.S. financial markets. Using asymmetric and nonlinear causality tests, as well as the extended DCC-GJR-GARCH model, we found evidence of an asymmetric and nonlinear unidirectional causal link from high-risk to low-risk bonds markets, which intensifies during bear markets. There is a bidirectional volatility and shock transmission only during normal bond market conditions. The high-risk bonds market induces more destabilizing effects in the corporate bond market than the low-risk bonds market. The time-varying, highly persistent, and negative correlation during normal market conditions provides the opportunity for combining low-risk and high-risk bonds to diversify a portfolio.

Keywords: Speculative; Investment; Asymmetric; Nonlinear; Volatility spillover; EDCC (search for similar items in EconPapers)
JEL-codes: G14 G12 G24 (search for similar items in EconPapers)
Date: 2019
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DOI: 10.1016/j.econmod.2018.12.017

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