Is the Cross-Section of Expected Bond Returns Influenced by Equity Return Predictors?

Abstract

A significant fraction of firms' financing occurs via public debt markets. Accordingly, we investigate whether financial statement characteristics and other variables that predict equity returns also predict corporate bond returns. Profitability, asset growth, and equity market capitalization negatively predict corporate bond returns, but other predictors, like accruals and earnings surprises, do not. Since smaller, unprofitable firms should be more risky, and firms with high asset growth (or high real investment) should have lower required returns, the evidence indicates that corporate bond returns accord with the risk-reward paradigm. Stock markets lead bond markets, consistent with equities aggregating diverse information and transmitting it to bonds. Overall, we find that accounting for transaction costs, bonds are efficiently priced.