FRIC/Finance seminar with Jaewon Choi, College of Business, University of Illinois
Upcoming seminar with Jaewon Choi, College of Business, University of Illinois.
On the fundamental relation between equity returns and interest ratesThis paper appeals to contingent claim asset pricing to exploit capital structure priority to better understand the relation between security returns and interest rate changes (i.e., duration). In particular, we show and, using a novel dataset, empirically confirm that lower priority securities in the capital structure, such as subordinated or distressed debt and equity, have low or even negative duration. This is because the lower priority securities are effectively short higher priority fixed rate debt, i.e., short the bond market. The finding has important implications for interpreting existing aggregate results in the literature such as (i) time-varying correlations between aggregate stock markets and government bonds, (ii) the Fisher effect and inflation, (iii) measuring the beta of corporate bonds, and (iv) using bond factors for multifactor asset pricing models and forecasting bond and stock returns.