Corporate Bond Market Research Articles

CORPORATE BOND MARKETS IN EASTERN EUROPE: TRENDS AND PROSPECTS

The purpose of the paper is to analyze the process of the corporate bond market formation in Eastern Europe and to determine the prospects for development in Ukraine. Methodology. It is justified that the main variables that affect corporate bond issues are loans granted to financial corporations (excluding banks) and non-financial corporations, share issues and equity. The empirical basis of the study is the reports of the National Securities and Stock Market Commission (on the amount of shares and bonds), the National Bank of Ukraine (on the amount of loans to corporations) and the State Statistics Service of Ukraine (on the amount of corporate equity). The study covers 20 years: from 2000 to 2019. Based on these data, a vector autoregressive model (VAR) was constructed. The forecast error variance decomposition (VDC) technique was used to identify the most influential variables in the corporate bond issuance process. Based on the VAR model, the forecast levels of model variables for 2021–2024 were obtained, which should have been achieved under the condition of planned development of the corporate bond market in Ukraine. It has been suggested that the economic shock of the COVID-19 has led to a decrease in the expected level of variables in 2020. Therefore, seven scenarios for the development of the corporate bond market are considered: A – reduction of equity amount; B – decrease in the amount of shares issued; C – decrease in the amount of loans to corporations; A + B; A + C; B + C; A + B + C. The results of the VDC technique have allowed to establish that the issue of corporate bonds in Ukraine largely depends on the amount of bank loans granted to corporations. Based on the VAR model and scenario forecasting, it was determined that the most favorable for the development of the corporate bond market of Ukraine is the scenario, in which corporations’ equity will be reduced by 10% due to increased uncovered loss but such a reduction will not lead to liquidation, and hence the cessation of circulation of their shares. Practical implications. Forecasting the amount of corporate bonds, shares and loans to corporations based on the proposed model allows companies to develop effective strategic plans, and investors – to decide on the allocation of their own financial resources. Value/originality. The proposed model of corporate bond market development in Ukraine includes internal and external sources of financing of enterprises, and allows to quantify the relationship between financial instruments (corporate bonds, loans and shares).

Sustainability premium in energy bonds

Abstract We investigate the extent to which belonging to a sustainable index leads to lower financing costs for companies in the energy industry. From an extensive sample that includes all energy bonds traded on the US corporate bond market between 2005 and 2014, we examine the differences between the yield spreads on bonds issued by green and non-green energy companies, based on the inclusion of issuers in the Dow Jones Sustainability Index. The yield spreads are computed from synthetic governmental bonds obtained discounting original cash flows from the zero-coupon yield curve. Controlling by bond fundamentals and market conditions, the sustainability premium averages 66 b.p. in yield spread terms. This premium depends on the credit quality of the issuer, ranging from 23 b.p. for investment grade bonds to 261 b.p. for junk bonds. This price premium that investors are willing to pay for the green energy company bonds entails a lower cost of debt for these companies.

Liquidity Pricing in Emerging Market Corporate Bonds

This paper examines liquidity pricing in emerging market corporate bonds that are traded in the US market. Average market-wide effective bid-ask spreads are 0.51%, and rise to 1.12% during the financial crisis. Using time series regressions, we find that portfolios with illiquid bonds perform worst when market liquidity deteriorates. Fama-MacBeth regressions with forward looking expected returns as the dependent variable show evidence in favor of a negatively priced liquidity risk factor, which is in accordance with standard theory. Portfolio characteristics proxying for the liquidity level are also important determinants of the cross-sectional variation in expected returns of emerging market corporate bonds, and reduce the effect of the liquidity risk factor. The results for a matching sample of US bonds show a different pattern: with only market risk and liquidity risk factors, the price of liquidity risk is counter-intuitively positive. When controlling for liquidity level proxies, the liquidity risk premium vanishes for the US bonds.

Price Discovery in China’s Corporate and Treasury Yield Curves

As financial development progresses, the maturity structure of bond yields plays a rising role not only in the financial system but also as a key transmission channel of monetary policy. China is likely to be no exception. However, specific characteristics in China’s bond markets raise two major questions. First do China’s Treasury bonds offer the benchmark term structure of yields, or is this role fulfilled by the young but fast expanding corporate bond market? In other words, where does price discovery take place in the Chinese bond market in terms of the different components of the yield curve? We identify both dynamic and long-run relationships between each of the level, slope and curvature factors of the Treasury and corporate bond markets yield curve in China. We aim at determining which market plays a leading role in the discovery of each factor of the yield curve. We obtain three main results. First, we document for the first time the presence of a long-run relationship between the corporate and Treasury bond markets in China both for the level and the slope of their yield curve. Second, such a long-run relationship appears to be stable between the slopes over the full sample 2006-2017, but shows a break for the level factor in 2012. Third, the source market for price discovery varies with the parameters of the yield curve. While the corporate bond market is the source of price discovery for the level factor, this function is fulfilled by the government bond market for the slope parameter. The finding that the Treasury bond market is not fully dominant in level bond-pricing may not come as a surprise. Although China’s corporate bond market has developed rapidly in the past fifteen years, there were few default cases during that period. It is believed investors treat the default risk of corporate bonds as similar to that of Treasury bonds, and benefit from the high corporate spread. Our results for the slope parameter imply that market-oriented reform has progressed enough for the Treasury bond market to already provide a benchmark slope for the yield curve of corporate bonds. When the reform progresses further, we would expect corporate bonds to be priced according to their risk profile which should make the Treasury market lead in price discovery also for the level of the yield curve.

The Importance of Investor Heterogeneity: An Examination of the Corporate Bond Market

Corporate bond market participants are increasingly worried about liquidity. However, bid-ask spreads and other standard measures indicate liquidity has not deteriorated significantly. This paper proposes a potential reconciliation. We show the sensitivity of credit yields to bid-ask spreads increased fourfold from 2005 to 2019. We then provide a model that connects this change to the rapid growth of mutual funds in the corporate bond market. The model features heterogeneous investors with different trading needs who choose between a risk-free asset and illiquid bonds. As the risk-free rate declines, more short-term investors reach for yield and enter the bond market. These short-term investors reduce the selling pressure in each sub-market and so the bid-ask spreads. However, their greater trading needs amplify the sensitivity of credit yields to the bid-ask spreads, leading to a larger liquidity component. We next test the model’s predictions using detailed data on investor holdings in the U.S. As predicted, we find investor turnover is associated with larger effects of illiquidity on credit yields. Bonds with more short-term investors are traded at lower bid-ask spreads, but their credit yields are more sensitive to the bid-ask spreads. Finally, we look across countries and show that, consistent with the model, larger declines in risk-free rates are associated with higher growth in mutual fund shares. These results highlight the key role that investor heterogeneity plays in determining how liquidity is priced into corporate bond yields and firms’ financing conditions.

The Growing Importance of the Economic Role of the Corporate Bond Market

The role of corporate bonds has expanded globally in the past decade, as they are an ideal financial instrument both for diversifying the liability structure of issuing companies and managing investors’ portfolios. An adequately developed, liquid corporate bond market has a beneficial effect on the functioning and transparency of the market mechanisms of the economy and can also strengthen the crisis resilience of the financial system. Several studies have shown that – in addition to the normal functioning of companies – the issue of corporate financing is also important in crisis management, as uncertainty during a crisis has a negative impact on the liquidity of bank lending, limiting companies’ funding options. In such a situation, it is therefore vital that companies can also rely on other forms of financing. Recognising this in the aftermath of the 2008–2009 economic crisis, central banks in a number of countries launched bond purchase programmes in order to start supporting the expansion of the corporate bond market. Thanks to the Bond Funding for Growth Scheme (BFGS) of the Magyar Nemzeti Bank (the Central Bank of Hungary, MNB), the Hungarian corporate bond market now offers a realistic financing alternative to bank loans for a wide range of companies.

Machine Learning in the Corporate Bond Market and Beyond: A New Classifier

Trade signing algorithms that rely on quote data, tick data or both have been used extensively to assign a trade as either a buy or a sell. Leveraging the availability of a large panel of signed trade data in the corporate bond market, we explore machine learning methods to uncover a new trade signing model that improves upon standard trade classification methods in both the bond and equity markets. We show that both the trading and information environment at the time of the trade critically affect the accuracy of existing trade classification rules in general, and also illustrate the importance of optimizing the feature set in correctly classifying trade direction. Importantly, our approach and the Random Forest algorithm we propose can be used in markets both with and without pre-trade transparency.

Dissecting Bond Volatility

This paper documents a positive cross-sectional relation between returns and lagged idiosyncratic volatility (IVOL) in the corporate bond market. The relation is stronger following periods of low funding liquidity due to a funding liquidity driven decrease in returns and its subsequent reversal. Three exogenous shocks – (i) the Volcker Rule which restricted the participation of dealers in the corporate bond market in 2014, (ii) the Global Financial Crisis of 2008, and (iii) the COVID-19 crisis of 2020, are used to establish causality between funding liquidity and the positive IVOL-return relation.

РЕГУЛЮВАННЯ ЕМІСІЇ ТА ОБІГУ КОРПОРАТИВНИХ ОБЛІГАЦІЙ У СХІДНОЄВРОПЕЙСЬКИХ КРАЇНАХ

The formation and development of the corporate bond market is influenced by global regulatory reform and other government policy initiatives that affect all financial markets. Political, legislative, regulatory and fiscal changes must be well adapted to support the viability of corporate bond markets (both domestic and international). Financial market policy in general should not slow down bond markets, but should ensure optimal interaction between investors and issuers. Historical examples show how regulation, legislation, and other aspects of public policy can stimulate or slow down corporate bond markets. Currently, access to bond markets is limited for most companies due to the high cost of issuance, but the corporate bond market continues to expand. Regulation of the corporate bond market is a key factor that determines the possibility of attracting financial resources through this debt instrument from domestic and foreign investors. In this respect, it is important to pay attention not only to the issue of specific new regulatory and policy initiatives, but also to a careful review of the overall legal and regulatory framework. The purpose of the article is to systematize and analyze the legal framework for the issuance and circulation of corporate bonds in Eastern Europe. The article lists the main transactions in corporate bonds during their life cycle. The difference between the concepts of "corporate bond issue" and "corporate bond circulation" is substantiated. An analysis of the specifics of corporate bond regulation on the example of Ukraine, Bulgaria, Poland, Romania, Slovakia, Slovenia, Hungary and Croatia is carried out. The list of the basic laws of the countries of Eastern Europe regulating issue and circulation of corporate bonds is given. The common and distinctive features in the reporting and methods of information disclosure by corporate bond issuers in Ukraine and other Eastern European countries are analyzed. The structure of the corporate bond issue prospectus is determined. The main innovations in the Ukrainian legislation on the regulation of the issue and circulation of corporate bonds are analyzed.

Credit in a Crisis: Effects of the Fed's Corporate Bond Market Intervention

We examine the effects of the Fed's Secondary Market Corporate Credit Facilities (SMCCF) on both firm-level outcomes and bond market conditions. Using secondary bond market transactions matched to corporate balance sheet data, we find borrowers did not raise real investment but increased their share of long-term debt. However, this effect is driven primarily by a flight-to-safety channel rather than the differential impact from SMCCF-eligibility. Moreover, using a bond-level difference-in-differences specification where each eligible bond is matched to an ineligible bond in terms of credit-rating, firm size and industry, we find substantial improvement in liquidity (bid-ask spreads) and cost of borrowing (bond yield). The program also improved bond valuations but the effect was economically small. Overall, our results indicate the Fed's intervention helped restore corporate bond market stability but had relatively smaller effect at the firm-level.

Covenant Prices of US Corporate Bonds

This paper provides a novel approach to empirically determine prices of bond covenants based on transaction data for the US corporate bond market. Thereby, we are the first to measure price effects over the whole lifetime of bond contracts. We find that covenant prices vary significantly over time and are associated with changes in market-wide credit risk, volatility, and macroeconomic variables. During and after the financial crisis, this relationship is particularly pronounced leading to significantly higher covenant prices in the range of 5% of the overall bond yields. Apart from these time-series dynamics, there is also significant variation across bond and firm characteristics. In particular, covenant prices increase with interest rate, credit, and liquidity risk and are higher for firms that have more growth options, more tangible assets, and are smaller. Furthermore, we document a positive correlation between the prices of covenants and their subsequent inclusion rates.

Risk Aversion in Corporate Bond Markets

Risk Aversion in Corporate Bond Markets

Liquidity in the German Corporate Bond Market: Has the CSPP Made a Difference?

The Eurosystem purchased €178 billion of corporate bonds between June 2016 and December 2018 under the Corporate Sector Purchase Programme (CSPP). Did these purchases lead to a deterioration of liquidity conditions in the corporate bond market, thus raising concerns about unintended consequences of large-scale asset purchases? To answer this question, we combine the Bundesbank's detailed CSPP purchase records with a range of liquidity indicators for both purchased and nonpurchased bonds. We find that while the flow of purchases supported secondary market liquidity, liquidity conditions deteriorated in the long-run as the Bundesbank reduced the stock of corporate bonds available for trading in the secondary market.

Measuring Corporate Bond Market Dislocations

We propose the Corporate Bond Market Distress Index (CMDI) to quantify corporate bond market dislocations in real time. The index takes a preponderance-of-metrics perspective to combine a broad set of measures of market functioning from primary and secondary markets but not driven by any one statistic. We document that the index correctly identifies periods of dislocations and predicts future realizations of commonly used measures of market distress, while the converse is not the case. Moreover, the CMDI is an economically and statistically significant predictor of future economic activity, even after controlling for standard predictors, including credit spreads.

The Relationship between Awareness and Retail Investors' Investment Intentions in the Indian Corporate Bond Market

Despite a long history, many committee recommendations, and ongoing changes, the Indian corporate bond market remains modest. Corporate Bond Market in India is majorly dominated by institutional investors and with lack of participation retail investors? participation due to due to a lack of awareness and understanding of the product. As a result, the purpose of this study is to determine the amount of retail investor awareness of corporate bonds, as well as the relationship between awareness and investment intention in corporate bonds. A questionnaire-based survey with a sample size of 400 respondents is being undertaken. The study's findings show that the majority of respondents have just average or below average awareness of corporate bonds, and that there is a substantial association between awareness and corporate bond investment intention. Keywords: Corporate Bonds, Awareness Level, Investment Intention, SEBI, CRISIL

Disagreement, Liquidity, and Price Drifts in the Corporate Bond Market

Disagreement, Liquidity, and Price Drifts in the Corporate Bond Market

Lighting Up the Dark: Liquidity in the German Corporate Bond Market

We study the impact of transparency on liquidity in OTC markets. We do so by providing an analysis of liquidity in a corporate bond market without trade transparency (Germany), and comparing our findings to a market with full post-trade disclosure (the U.S.). We employ a unique regulatory dataset of transactions of German financial institutions from 2008 until 2014 to find that: First, overall trading activity is much lower in the German market than in the U.S. Second, similar to the U.S., the determinants of German corporate bond liquidity are in line with search theories of OTC markets. Third, surprisingly, frequently traded German bonds have transaction costs that are 39-61 bp lower than a matched sample of bonds in the U.S. Our results support the notion that, while market liquidity is generally higher in transparent markets, a sub-set of bonds could be more liquid in more opaque markets because of investors crowding their demand into a small number of more actively traded securities.

The Pandemic Crisis Shows that the World Remains Trapped in a 'Global Doom Loop' of Financial Instability, Rising Debt Levels, and Escalating Bailouts

In January 2020, I completed a book (Taming the Megabanks: Why We Need a New Glass-Steagall Act) analyzing the financial crises that precipitated the Great Depression of the 1930s and the recent Great Recession. My book argued that the world’s financial system was caught in a “global doom loop” at the beginning of 2020. Bailouts and economic stimulus programs during and after the global financial crisis of 2007-09 (GFC) imposed heavy debt burdens on most governments, and leading central banks were carrying bloated balance sheets. The rescues arranged by governments and central banks during the GFC created a widely-shared expectation that they would continue to intervene to ensure the stability of major financial institutions and important financial markets. That expectation encouraged speculative risk-taking by financial institutions and investors as well as dangerous growth in private and public debts. I warned that the global doom loop was planting the seeds for the “next” financial crisis, which could overwhelm the already strained resources of governments and central banks.The “next” global crisis began only two months later, in March 2020. The rapid spread of the Covid-19 pandemic caused governments in most developed countries to shut down large sectors of their economies and impose social distancing mandates. Many thousands of businesses closed, setting off a downward spiral in economic activity that paralyzed global financial markets. Investors, businesses, and financial institutions “scrambled for cash” and engaged in panicked “fire sales” of financial assets. Governments and central banks in the U.S. and other advanced economies adopted fiscal stimulus measures and financial rescue programs with a size, speed, and scope that far surpassed the emergency actions taken during the GFC.The pandemic financial crisis and the extraordinary responses of governments and central banks demonstrate that policymakers have not addressed the root causes of the GFC. Major financial institutions and financial markets remain highly unstable. They continue to underwrite rapidly rising levels of private and public debts based on their shared expectation of future government bailouts. Governments and central banks have expanded their “safety nets” far beyond banks and now protect the entire financial system, including short-term wholesale credit markets, systemically important nonbanks, and the corporate bond market. As a practical matter, governments and central banks have “bankified” the financial system, thereby undermining market discipline, stimulating dangerous asset bubbles, and increasing social inequality.Our financial system must be reformed so that it no longer promotes unsustainable booms, fueled by reckless growth in private debts, followed by destructive busts that require massive bailouts and huge increases in government debts. My recent book provides a blueprint for needed reforms, including a new Glass-Steagall Act. A new Glass-Steagall Act would break up financial giants by separating banks from the capital markets and by prohibiting nonbanks from financing their operations with functional substitutes for bank deposits. A new Glass-Steagall Act would establish a financial system that is more stable, more competitive, and more responsive to the needs of consumers, communities, and business firms. Properly implemented, a new Glass-Steagall Act would provide the most direct and practical way to break the global doom loop and end the toxic boom-and-bust cycles of the past quarter century.

Speculation and Liquidity in Stock and Corporate Bond Markets

Speculation and Liquidity in Stock and Corporate Bond Markets

Bond Price Fragility and the Structure of the Mutual Fund Industry

We show that mutual funds with a large share of a bond issue sell their holdings of that issue to a lower extent when they experience redemptions, arguably because they attempt to avoid a drop in the bond price and the consequent negative feedback effects on the unsold part of their position. As a consequence, bond issues with more concentrated ownership experience higher returns during periods of turmoil and have lower price volatility. We provide evidence that the stabilizing trading of bond funds with a large share of an outstanding issue can help explain how the intervention of the Fed in the corporate bond market through the Secondary Market Corporate Credit Facility quickly stabilized both eligible and ineligible bonds.