Initial Evidence on the Role of Accounting Earnings in the Bond Market

Abstract

We document that: (1) the incidence of bond trade increases during the days surrounding earnings announcements, (2) there is a bond‐price reaction to the announcement of earnings, and (3) there is a positive association between annual bond returns and both annual changes in earnings and annual analysts' forecast errors. All of these effects are larger when earnings convey bad news or when the underlying bond is more risky. Taken together, our results suggest that the nonlinear payoff structure of bond securities affects the role of accounting earnings in the bond market.

Aggregate Earnings and Corporate Bond Markets

“…Further, I find that the aggregate earnings‐returns relation is lower (i.e., less positive or more negative) for bonds with higher credit ratings and longer maturities. My results differ from the firm‐level finding of a positive relation between earnings changes and corporate bond returns, and from the finding that the earnings‐returns relation for corporate bonds at the firm level depends only on corporate bond credit ratings (e.g., Datta and Dhillon [], Easton, Monahan, and Vasvari []).…”

Impact of New Debt Offerings on Existing Corporate Bondholders

“…A −17 basis point return in three days is equivalent to a compound annualized return of −19%. The returns in our work are much larger than those found by Easton, Monahan, and Vasvari () and Defond and Zhang (), who study bond market reactions to earnings announcements.…”

The Direct Relevance of Accounting Information for Credit Default Swap Pricing

“…Aunon‐Nerin et al (2002), in their study of the determinants of CDS price levels, verify that ratings are the single most important source of information on credit risk overall, while Micu et al (2006) note that a variety of rating agency announcements have a significant effect on CDS prices. Finally, although evidence suggests that the CDS market leads the corporate bond market in credit risk price discovery, traders often reference corporate bond prices, which appear to be affected by accounting earnings (Easton et al, 2009), as a baseline for CDS valuation 3…”