Events

Professor Philippe Mueller
Professor of Finance
Warwick Business School
University of Warwick

We show that firm default risk is the primary predictor of the correlation between corporate bond and stock returns, both in the cross-section and over time. Bonds of less creditworthy firms behave more like the issuing firms’ stocks, resulting in higher future comovement. As a direct implication, investing in bonds and stocks of the most creditworthy firms significantly enhances diversification benefits and Sharpe ratios out-of-sample. We develop a structural model with stochastic asset variance that rationalizes these findings, whereby time-variation in asset variance plays a critical for breaking down the perfect stock-bond correlation implied by the Merton model.