Breadth of Ownership and the Cross-Section of Corporate Bond Returns

Abstract

We investigate the effects of short sale constraints on asset mispricing in the corporate bond market. Consistent with Miller (1977)’s theory that short sale constraints can lead to asset overpricing, we document a significant positive relation between changes in ownership breadth (a proxy for short sale constraints) and the cross-section of future corporate bond returns. The return predicative power of changes in breadth is shown to be relatively short-lived in the corporate bond market, possibly due to the bounded upside payoffs of debt. Further analysis shows that the return predictability of changes in breadth is stronger among bonds with higher credit risk and during periods of high investor sentiment, and is mainly driven by bond overpricing rather than underpricing. Overall, the impact of short sale constraints on bond mispricing appears to be more pronounced when overpricing is more likely.