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Takeover risk and the correlation between stocks and bonds

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  • Bhanot, Karan
  • Mansi, Sattar A.
  • Wald, John K.

Abstract

Existing research suggests that, for a given firm, stock returns and bond prices are positively related, and this implies a negative relation between stock returns and bond spreads. In this paper, we show how takeover risk influences this relation. Bondholders of high-rated firms can suffer losses in a takeover, particularly if the takeover is largely funded with debt, resulting in a more positive (or less negative) correlation between stock returns and bond spread changes. Consistent with this notion and based on a large sample of data covering the period from 1980 to 2000, we find that high-rated firms which are likely to be taken over have a more positive correlation between stock returns and bond spread changes, while target firms with a poison put or an indebtedness covenant have a more negative correlation. Overall, our findings have implications for the pricing and hedging of bonds and default risk based financial products such as credit default swaps.

Suggested Citation

  • Bhanot, Karan & Mansi, Sattar A. & Wald, John K., 2010. "Takeover risk and the correlation between stocks and bonds," Journal of Empirical Finance, Elsevier, vol. 17(3), pages 381-393, June.
    • Handle: RePEc:eee:empfin:v:17:y:2010:i:3:p:381-393
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    2. Demirovic, Amer & Guermat, Cherif & Tucker, Jon, 2017. "The relationship between equity and bond returns: An empirical investigation," Journal of Financial Markets, Elsevier, vol. 35(C), pages 47-64.
    3. Ansgar Belke & Christian Gokus, 2011. "Volatility Patterns of CDS, Bond and Stock Markets Before and During the Financial Crisis – Evidence from Major Financial Institutions," Ruhr Economic Papers 0243, Rheinisch-Westfälisches Institut für Wirtschaftsforschung, Ruhr-Universität Bochum, Universität Dortmund, Universität Duisburg-Essen.
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    5. Arun Upadhyay & Hongchao Zeng, 2017. "Cash holdings and the bargaining power of R&D-intensive targets," Review of Quantitative Finance and Accounting, Springer, vol. 49(4), pages 885-923, November.

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