Investor sentiment,flight-to-quality,and corporate bond comovement |
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Institution: | 1. University of Cologne, Department of Business Administration and Finance, Albertus-Magnus-Platz, 50923 Cologne, Germany;2. Centre for Financial Research, University of Cologne, Germany;3. University of Hohenheim, Department of Risk Management, Schwerzstr. 42, 70599 Stuttgart, Germany;2. Faculty of Economics of Sciences, Ozyegin University, Nisantepe Mah. Orman Sok. No 34-36, Alemdag/Cekmekoy, 34794, Istanbul, Turkey\n |
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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. |
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