Journal
JOURNAL OF BANKING & FINANCE
Volume 82, Issue -, Pages 112-132Publisher
ELSEVIER SCIENCE BV
DOI: 10.1016/j.jbankfin.2017.02.007
Keywords
Bond correlation; Risk factor correlation; Flight-to-quality; Investor sentiment
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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. (C) 2017 Elsevier B.V. All rights reserved.
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