Stock-bond return co-movement and accounting information

Stefano Cascino

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: I examine how an important attribute of financial reporting quality, i.e., accounting conservatism, affects the sensitivity of corporate bond returns to changes in the value of equity (i.e., the hedge ratio). The correlation between stock and bond returns (comovement) is a fundamental input for asset allocation decisions as it determines the diversification benefits of bonds relative to equities within an investment portfolio. According to structural models of credit risk, co-movement should be generally positive, but lower when the risk of wealth transfers from bondholders to shareholders is severe. I find that firms that report conservative earnings and use covenants in their bond contracts exhibit on average stronger co-movement. This result is consistent with conservatism providing bondholders with a credible and contractible signal that improves monitoring thus preventing wealth transfers.

Keywords: stock-bond correlation; co-movement; asset allocation; hedge rations; credit risk; wealth transfers; accounting conservatism; debt covenants (search for similar items in EconPapers)
JEL-codes: G12 G32 M41 (search for similar items in EconPapers)
Pages: 37 pages
Date: 2017-07-01
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

Published in Journal of Business Finance and Accounting, 1, July, 2017, 44(7-8), pp. 1036 - 1072. ISSN: 0306-686X

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