Intra-Market Correlations in the Bond Markets: Extending Empirical Regularities from the Equity Markets

Abstract

Capital markets in general, and equity markets in particular, exhibit a well-known phenomenon: During times of distress, intra-market correlations tighten, as assets exhibit greater sensitivity to the “systematic factor.” This paper extends that analysis to corporate bonds, examining intra-market correlation of both yields and yield spreads. The intra-market correlations of bond rates, as represented by the sum of Treasury rates and CDS levels, do not show similar behavior, as the corporate component is overwhelmed by the effect of Treasury rates on the correlation. However, intra-market correlations of corporate spreads, as represented by liquid corporate CDS levels, tightened during the recent crisis. These results constitute a potential roadmap for construction of optimal bond portfolios and execution of active strategies. Whereas most components of capital markets have substantially recovered from crisis magnitudes, our analysis of pair-wise CDS correlations demonstrates partial recovery—but, as of 2015, not yet to pre-crisis levels.