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Investor sentiment, flight-to-quality, and corporate bond comovement

Sebastian Bethke, Monika Gehde-Trapp and Alexander Kempf

Journal of Banking & Finance, 2017, vol. 82, issue C, 112-132

Abstract: We examine the dynamics of bond correlation using a broad sample of US corporate bonds, and document that bond correlation varies heavily over time. We attribute this variation in bond correlation to variation in risk factor correlation reflecting time-varying flight-to-quality behavior of investors. We show that risk factor correlation increases when investor sentiment worsens, i.e., corporate bond investors exhibit stronger flight-to-quality when their sentiment is bad. Thus, bad investor sentiment leads to flight-to-quality behavior and, ultimately, high bond correlation. Very good sentiment, in contrast, can cause risk factor correlation and bond correlation to be negative.

Keywords: Bond correlation; Risk factor correlation; Flight-to-quality; Investor sentiment (search for similar items in EconPapers)
JEL-codes: G11 G12 (search for similar items in EconPapers)
Date: 2017
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