Investor Sentiment and Speculative Bond Yield Spreads

Abstract

The valuation of risky debt is central to theoretical and empirical work in corporate finance. Although much is known on the returns and valuation of bonds, there is hardly a consensus on the risk components of the yield spreads. This article aims to investigate the effect of investor sentiment as a systematic risk factor on speculative bond yield spreads. After applying correlation analysis to determine the strength of linear association between these two variables, a vector autoregressive (VAR) analysis and impulse response tests are used to examine the relationship between these two variables. The sample period extends from January 1997 to August 2014. In the VAR models, speculative bond spreads and consumer confidence index are used as endogenous variables. The results show that sentiment covaries with the yield spread and have a negative effect on them. The spread level of the previous period seems to be a statistically significant determinant of the current period sentiment. Empirical findings imply that investor sentiment is a systematic risk factor in risky bond markets.

Influence of COVID-induced fear on sovereign bond yield

“…In the same vein, the COVID factor was a shock like the 2008 financial crisis, the macro-fiscal cost of government rescue efforts resulting from the impact of the pandemic on the economy generated an immediate fear of higher fiscal deficits and debt leading to a deterioration of country risk. In this regard, the effects of the COVID factor are not only felt in the short term, but also in the long term as Cevik and € Ozt€ urkkal (2020) suggested by forecasting the possibility of higher sovereign financing costs From a behavioral perspective, this result supports previous studies such as those by Laborda and Olmo (2014) in the case of the US Treasury bond market and Muldur et al (2019) with risky bonds showing how sentiments can explain bond risk premiums. Moreover, specifically, the positive relationship between COVID-induced fear and the sovereign bond yield supports what was obtained by Naeem et al (2021), showing that while this fear is associated with reductions in stock market returns (Ly ocsa et al, 2020;Salisu & Akanni, 2020;Vasileiou, 2021), it is also associated with increases in bond yields.…”

“…By using four decades of U.S. Treasury bond data, Laborda and Olmo (2014) found evidence that bond risk premiums can be explained by investor sentiment dynamics as a predictive factor, being more relevant during recession periods. Further evidence is found with U.S. speculative bonds; Muldur et al (2019) pointed out that investor sentiment is a systematic risk factor in risky bonds. Their yield spreads co-vary with investor sentiment.…”