Investor sentiment and corporate bond yield spreads

Authors

  • Subhankar Nayak

    Corresponding author
    1. Financial Services Research Centre, School of Business and Economics, Wilfrid Laurier University, Waterloo, Ontario, Canada
    • Assistant Professor, Finance, Financial Services Research Centre, School of Business and Economics, Wilfrid Laurier University, 75 University Avenue West, Waterloo, ON N2L 3C5, Canada.
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Abstract

Although the pervasive influence of investor sentiment in equity markets is well documented, little is known about behavioral manifestations in bond markets. In this paper, we explore the impact of investor sentiment on corporate bond yield spreads. Our results reveal that bond yield spreads co-vary with sentiment, and sentiment-driven mispricings and systematic reversal trends are very similar to those for stocks. Bonds appear underpriced (with high yields) during pessimistic periods and overpriced (with low yields) when optimism reigns. Consequent reversals result in predictable trends in post-sentiment yield spreads. When beginning-of-period sentiment is low, subsequent yield spreads are low; high sentiment periods are followed by high spreads. High-yield bonds (low ratings, Industrials and Utilities, extreme maturities or low durations, specially if low rated) demonstrate greater susceptibility to mispricings due to sentiment compared to low-yield bonds. The incremental yield spread gap between high- and low-yield bonds converges subsequent to periods of low sentiment, and diverges after high sentiment. Equity attributes marginally influence the impact of sentiment on bond spreads, but mostly for distressed bonds only. Copyright © 2010 John Wiley & Sons, Ltd.

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