Bethke, Sebastian Gehde-Trapp, Monika Kempf, Alexander
CFR Working Paper 13-06 [rev.3]
We examine the dynamics of bond correlation using a broad sample of US corporate bonds, and document that bond correlation varies heavily over time. We attribute this variation in bond correlation to variation in risk factor correlation reflecting time-varying flight-to-quality behavior of investors. We show that risk factor correlation increases when investor sentiment decreases, i.e., corporate bond investors exhibit stronger flight-to-quality when their sentiment is low. Thus, low investor sentiment leads to flightto- quality behavior and, ultimately, high bond correlation.
bond correlation risk factor correlation flight-to-quality investor sentiment