Capital Structure Priority Effects in Durations, Stock-Bond Comovements and Factor-Pricing Models
Review of Asset Pricing Studies, forthcoming
78 Pages Posted: 12 Sep 2013 Last revised: 15 Feb 2022
There are 2 versions of this paper
Capital Structure Priority Effects in Durations, Stock-Bond Comovements and Factor-Pricing Models
On the Fundamental Relation between Equity Returns and Interest Rates
Date Written: September 1, 2021
Abstract
We show theoretically and empirically that the durations of corporate securities are monotonically related to their capital structure priority, with equity often having negative duration. The magnitude of this effect increases with firm leverage. We use these insights to challenge existing results on stock-bond comovements and factor pricing. For example, though overlooked, higher leverage and lower priority reduce the correlation between corporate security and government bond returns and these variables explain time-series and cross-sectional variation in correlations; traditional market model regressions significantly understate corporate bond betas; regressions on standard term and default factors dramatically overstate interest rate and default risk.
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