Relations between Corporate Bonds, Treasuries and the Equity Market: Evidences from Daily Options Adjusted Credit Spreads

Abstract

This paper studies the complex relations existing between corporate bonds, treasuries and the equity market. It provides evidences that robust equilibrium relations exist between investment and speculative credit spreads indexes and the other markets. The equilibrium elasticity of the credit spreads to the stock market is function of the credit risk: the lower the rating, the higher the sensitivity. Determinants of credit spread returns are then explored. It is found that the one-day lagged deviation from the equilibrium relations has only a limited effect. This result weakens its importance on the continuous rebalancing of credit portfolios.

Keywords: Credit spreads, equity market, long run relation, short term dynamics

JEL Classification: G32, G12, G14