Wednesday, March 26, 2014 | 2:00pm - 3:30pm | Room 335, HSBC Business School Building

Abstract

The equity and corporate bond markets are integrated through sentiment-driven mis-pricing, not through rational pricing. Investment-based theories and structural credit risk models do not explain simultaneously the cross sections of equity and bond returns. In particular, profitability and net issuance anomalies do not exist in the corporate bond market. The risk premia associated with asset growth and investment anomalies are not consistent with structural credit risk models, although the two anomalies exist in the bond market. Rather, there exists strong sentiment-driven co-movement in the risk premia as-sociated with anomaly variables. Such co-movement is not explained by business cycles and shows common mispricing in equity and corporate bonds. In conclusion, rational pricing theories only partially explain the joint cross sections of returns, while investor sentiment drives co-movement in mispricing in the two markets.