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The Interaction between Credit Risk, Equity Returns and Fundamental Macro Valuations: An Attempt at Alignment in a Systemic Relationship?

The USA credit default concerns kept investors worldwide trying to interpret the implications for the American economy and its financial markets and institutions, in the mid and late 1970's, late 1980's and early 1990's, 2000s-2002 and most recently through 2007 and entering 2008. This raises an important question: Does the default premium in average rated corporate bonds, such as those rated BAA for example, provide useful signaling information about the concurrent and future state of the economy and of the stock market?. Moreover, since both the stock market and the bond market reflect concurrent investors sentiments and expectations about the future, what does this simultaneous pricing tell us about credit and equity markets interactive ability to discount the future aggregate national product into the present? These are the questions which are motivating this paper. The paper goes further than previous studies which investigated those relationships and adds some significant insights in its approach.