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Is Corporate Bond Market Performance Driven by Stock Market Performance?

Stock markets and bond markets are known to interact. Specifically, the common stock market trend (i.e., business cycle also termed market / systematic risk) impacts common corporate bond market trend (i.e., credit cycle). First, we disentangle the common latent component from total stock returns (i.e., systematic / unobserved common stock market component). Second, we extract the common latent component from total bond returns (i.e., common unobserved systematic corporate bond component). Then, we estimate the dynamic relation between systematic total stock returns and systematic total bond returns over time (i.e., co- and anti-monotonicity risk). We characterize therefore the time-varying correlation risk (i.e., correlation risk structure) between stock performance and corporate bond performance. Results are instructive in a risk management prospect with regard to equity- and corporate bond-based portfolios.