"Price Spillovers on the Corporate Bond Market"

Abstract

In the corporate bond market, a demand shock to a single bond moves its price little relative to similar bonds, whereas a shock to an entire rating or maturity segment moves prices substantially. I develop a dynamic asset pricing model in which heterogeneous portfolios and costly rebalancing shape price spillovers. When one bond becomes expensive, the funds that hold it swap it for similar bonds they already own; when their whole portfolio becomes expensive, they must expand into new bonds, which is slow. In equilibrium, price adjustment is governed by a coholding network that organizes bonds into overlapping habitats: clusters of bonds that share owners. Mispricing within a habitat dissipates quickly, whereas mispricing common to a habitat persists. In mutual fund holdings, these habitats align with rating and maturity, which explains part of why shocks along these characteristics move prices more.