A contingent claims approach to the determinants of the stock-bond return relationship

Chen, Louisa Chen and Verousis, Thanos (2018) A contingent claims approach to the determinants of the stock-bond return relationship. International Journal of Banking, Accounting and Finance, 9 (1). pp. 1-18. ISSN 1755-3830

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Abstract

This paper decomposes two effects on a firm’s stock and bond returns - the effect of firm’s future cash flow and the effect of business risk to study the relationship between the returns of stocks and bonds issued by the same firm. Based on the contingent claims option pricing theory, we employ firm-level data and an event study methodology, and generate hypotheses regarding the stock-bond return relationship. We show that, by controlling for firm’s leverage, firm’s future cash flow has a simultaneous positive effect on firm’s stock and bond returns, whereas firm’s business risk has a decoupling effect on stock and bond returns. In addition, we provide evidence for the “flight to quality” hypothesis at a firm-specific level. Our findings complement the literature of stock and bond correlation within a theoretical framework.

Item Type: Article
Schools and Departments: School of Business, Management and Economics > Business and Management
Subjects: H Social Sciences
Depositing User: Tahir Beydola
Date Deposited: 15 Feb 2018 15:12
Last Modified: 24 Apr 2018 15:01
URI: http://sro.sussex.ac.uk/id/eprint/73608

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