Behavioral biases in the corporate bond market

Abstract

This paper investigates the behavioral biases in the corporate bond market through the cross-section association between retail and institutional trades and corporate bond returns. The study finds that bonds heavily bought by retail investors in one month underperform in the next month relative to bonds heavily sold, and the opposite holds for institutional investors. The alpha of the high-low portfolio (formed based on decile sorting on the buy–sell trade imbalance) relative to the usual market factors is significant for retail investors, but insignificant for institutional investors. The overall results indicate that retail investors in the corporate bond market suffer from behavioral biases but institutional investors do not. However, when the spread between the purchase and sell prices is factored into the returns, no profitable trading strategies exist, consistent with limits to arbitrage.