Initial Evidence on the Role of Accounting Earnings in the Bond Market



    1. University of Notre Dame
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    1. INSEAD
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    1. London Business School. We thank Ray Ball (the editor), Robert Battalio, Nick Barberis, Donal Byard, Helen Choy, Shane Corwin, Carla Hayn, Art Kraft, Wayne Landsman, Rick Mendenhall, Jim Ohlson, Shiva Shivakumar, Wayne Thomas, Joe Weber, Regina Wittenberg-Moerman, an anonymous reviewer and seminar participants at the 2007 CARE Conference (Napa Valley), 2007 Penn State Accounting Research Conference, 2007 Tel Aviv Accounting Conference, 6th Annual London Business School Symposium, Baruch College, University of California at Riverside, Erasmus University, Lancaster University, London Business School, Tilburg University, the Swedish Institute for Financial Research, The University of Melbourne, and the University of Notre Dame for helpful comments. Steve Monahan and Florin Vasvari acknowledge financial support received from the INSEAD Alumni Fund and the London Business School RAMD Fund, respectively.
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We document that: (1) the incidence of bond trade increases during the days surrounding earnings announcements, (2) there is a bond-price reaction to the announcement of earnings, and (3) there is a positive association between annual bond returns and both annual changes in earnings and annual analysts' forecast errors. All of these effects are larger when earnings convey bad news or when the underlying bond is more risky. Taken together, our results suggest that the nonlinear payoff structure of bond securities affects the role of accounting earnings in the bond market.