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In Rememberance: World Trade Center (WTC)

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Corporate Bond Credit Spreads and Forecast Dispersion

by Levent GŁntay of Federal Deposit Insurance Corporation, and
Dirk Hackbarth of University of Illinois at Urbana-Champaign

October 2010

Abstract: Recent research establishes a negative relation between stock returns and dispersion of analysts' earnings forecasts, arguing that asset prices more reflect the views of optimistic investors because of short-sale constraints in equity markets. In this article, we examine whether a similar effect prevails in corporate bond markets. After controlling for common bond-level, firm-level, and macroeconomic variables, we find evidence that bonds of firms with higher dispersion demand significantly higher credit spreads than otherwise similar bonds and that changes in dispersion reliably predict changes in credit spreads. This evidence suggests a limited role of short-sale constraints in our corporate bond data sets. Consistent with a rational explanation, dispersion appears to proxy largely for future cash flow uncertainty in corporate bond markets.

JEL Classification: G12, G32, G33.

Keywords: Analyst forecasts, Corporate bonds, Credit risk, Earnings volatility.

Published in: Journal of Banking and Finance, Vol. 34, No. 10, (October 2010), pp. 2328-2345.

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