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

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posted on 2023-06-09, 12:10 authored by Louisa ChenLouisa Chen, Thanos Verousis
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.

History

Publication status

  • Published

File Version

  • Accepted version

Journal

International Journal of Banking, Accounting and Finance

ISSN

1755-3830

Publisher

Inderscience

Issue

1

Volume

9

Page range

1-18

Department affiliated with

  • Accounting and Finance Publications

Full text available

  • Yes

Peer reviewed?

  • Yes

Legacy Posted Date

2018-02-15

First Open Access (FOA) Date

2018-07-17

First Compliant Deposit (FCD) Date

2018-02-15

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