Informed Bond Trading, Corporate Yield Spreads, and Corporate Default Prediction

Abstract

T aking advantage of recently augmented corporate bond transaction data, we examine the pricing implications of informed trading in corporate bonds and its ability to predict corporate defaults. We find that microstructure measures of information asymmetry seem to capture adverse selection in corporate bond trading reasonably well. We demonstrate that information asymmetry in bond trading has explanatory power for corporate bond yield spreads, and this result holds after controlling for the transaction costs of liquidity, credit risk, and other traditional bond pricing factors. Furthermore, information asymmetry can help forecast corporate defaults after conditioning on other default prediction variables. Such forecasting ability of informed bond trading is especially useful for private firms because the bond market constitutes the only venue for informed traders to exploit their information advantages.

Are Low Equity R2 Firms More or Less Transparent? Evidence from the Corporate Bond Market

“…The signs and significance of the remaining control variables are generally consistent with the results of Model 1. These findings support Hypothesis H2a and the findings of related research (Han and Zhou, ). Information risk is an important risk factor to investors of bonds with a greater likelihood of default.…”

“…In Table , Panel B, we re‐estimate Equation using the transaction‐level yield spread data. The main difference of this sample from the at‐issue sample is the elevated role of informed bond trading (Han and Zhou, ) that can further exacerbate the information uncertainty faced by uninformed bond investors. As a result, transaction‐level prices reflect information risk even more strongly via the trading process, leading to a pronounced Synchronicity effect on yield spread.…”

“…Other work demonstrates that bond transactions reflect information risk. Han and Zhou () identify a strong and persistent adverse selection component of bond yield spreads, especially for high yield and private firm debt. Similarly, Wittenberg‐Moerman () provides an additional insight that the primary source of informational advantage among informed traders in the corporate debt market is the receipt of more timely and frequent firm‐specific information from corporate insiders resulting in adverse selection risk to uninformed bond investors.…”

“…This is consistent with Kwan's () evidence that speculative grade bond yields are particularly sensitive to firm‐specific information reflected by the issuing firms’ stock returns. In addition, Han and Zhou () demonstrate that bonds that are closer to default are more sensitive to information impairment suggesting that investors holding high yield bonds require a relatively higher risk premium leading to a stronger sensitivity of yield spread to return synchronicity: H2a: The negative relation between stock return synchronicity and yield spread is stronger for high yield bonds. …”

Information and Liquidity of OTC Securities: Evidence from Public Registration of Rule 144A Bonds

“…The entrance of retail investors post registration will likely cause lower trading activity as they tend to behave more like "buy-and-hold" investors than QIBs. Retail investors may also interpret public information less efficiently than QIBs (e.g., Kandel andPearson 1995, Han andZhou 2014). The change of the investor base, post registration, may therefore lead to a clientele effect on our results.…”