Investor Sentiment and Corporate Bond Yield Spreads

Abstract

Although the pervasive influence of investor sentiment in equity markets is well documented, little is known about behavioral manifestations in bond markets. In this paper, we explore the impact of investor sentiment on corporate bond yield spreads. Our results reveal that bond yield spreads co-vary with sentiment, and sentiment-driven mispricings and systematic reversal trends are very similar to those for stocks. Bonds appear underpriced (with high yields) during pessimistic periods and overpriced (with low yields) when optimism reigns. Consequent reversals result in predictable trends in post-sentiment yield spreads. When beginning-of-period sentiment is low, subsequent yield spreads are low; high sentiment periods are followed by high spreads. High-yield bonds (low ratings, Industrials and Utilities, extreme maturities or low durations, specially if low rated) demonstrate greater susceptibility to mispricings due to sentiment compared to low-yield bonds. The incremental yield spread gap between highand low-yield bonds converges subsequent to periods of low sentiment, and diverges after high sentiment. Equity attributes marginally influence the impact of sentiment on bond spreads, but mostly for distressed bonds only.

Investor Sentiment and Speculative Bond Yield Spreads

“…Nevertheless, because of complexity and sophistication of the financial markets, attention has been shifted toward bonds and derivatives markets. Although there are two studies revealing the role of investor sentiment in pricing corporate bonds (Nayak, 2010;Laborda and Olmo, 2013), there is a lack of empirical evidence about speculative bond yield spreads. Using 196 monthly observations, between January 1997 and August 2014, this study aims to answer these questions using a correlation and VAR analysis.…”

“…However, a considerable amount of empirical work shows that security price movements often fall beyond the reasonable explanations based on rational investors and risk-based pricing models. This has led to a rise in interest for behavioral aspects of financial markets (Nayak, 2010). Only since the mid-1980s, there has been a serious attempt to explore the possibility that financial markets are not always as smooth as might be suggested by the efficient market hypothesis (Brown and Cliff, 2004).…”

Debt Ipo Waves, Investor Sentiment, Market Conditions, and Issue Quality

“…Nayak () finds that bonds appear underpriced during low‐sentiment periods, which can lead to higher yields; they are likely overpriced when they are associated with lower yields when investor optimism reigns. Furthermore, Nayak reports that sentiment‐driven mispricing is more severe among high‐yield bonds.…”

Investor Sentiment and Asset Pricing: A Review

“…This argument is consistent with prior research that the irrationality persists mostly among less sophisticated investors, individuals. Nayak (2010) documents that the bond yield spreads co-vary with sentiment, and sentiment-driven mispricing and systematic reversal trends are very similar to those for stocks. This suggests that investors decide wealth allocations and trade between debt and equity based on their current and future expectations about the economy's status.…”