What Drives Corporate Bond and Treasury Yield Correlation
Summary
Corporate bond yields combine a Treasury-related risk-free component with a credit and liquidity spread. The relative size of these components helps explain why investment-grade bonds tend to move more closely with comparable-maturity Treasury yields, while high-yield and distressed bonds are more influenced by spreads and recovery expectations. Higher coupons can also make a bond somewhat less sensitive to rates before maturity.
The response describes spreads as having generic components related to country, credit quality, and tenor, alongside issuer-specific components that may co-move across that issuer’s maturities. It reports that sector separation, currency, and comparisons with equities, implied volatility, and commodities were not useful in the historical analysis cited. Those results are unpublished and not quantified here; the discussion is general guidance rather than a measured correlation model, and large unexpected rate moves may affect some industries’ spreads.
Key ideas
- Corporate bond yields combine risk-free rates with credit, liquidity, and other spreads.
- Investment-grade yields tend to be more rate-sensitive than high-yield yields.
- A bond’s maturity and coupon influence its sensitivity to Treasury rates.
- Distressed bonds may respond more to recovery expectations than to risk-free rates.
- The cited analysis distinguishes generic spreads from issuer-specific spreads, but its findings are unpublished.
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# Correlation between corporate bonds and treasury # Correlation between corporate bonds and treasury What aspects decide the correlation between US corporate bonds and US treasury ? I was told that some corporate bonds are more sensitive to treasury than others. Sectors or maturity? ## Answer by Dimitri Vulis (score 4) https://quant.stackexchange.com/a/65707 The yield of a corporate bond can be split into the risk-free part, which is by constuction highly correlated to treasury yields; and the extra spread that the bond holders demand to compensate for credit, liquidity, and other risks. For an investment grade bond, the risk-free part is a relatively larger part of the bond yield, so the yield is more correlated to risk-free rates in the same tenor bucket as the bond's maturity. Conversely, for a higher-yield (junk) bond, the risky spread is relatively larger, so their yields are less correlated to risk-free rates than IGs'. Further, bond paying relatively high coupons, are affected a little by the risk-free rates before their maturity. Distressed bonds on the verge of default are driven much more by their recovery assumption than by risk-free rates. In general, there's no material correlation ($\rho$) between the risky spread and small movements of interest rates. Large unexpected movements do sometimes affect ($\tau$) some industries' credit spreads , similar to how they afect equity, and similarly hard to quantify or predict. Edit: I've decided to mention the results (unpublished, of course) obtained by some former collegues who had access to lots of great historical data on risky bonds. A bond's extra speead can be further split into two spreads: - a "generic" spread that depends on the country of risk and on credit quality, is correlated to similar credit spreads (e.g. France B to Gemany BB), and of course between tenors (e.g. France B 5Y to France B 10Y) and is not materially correlated to interest rates. Surprisingly, trying to separate these spreads by sector/industry was not useful. Trying to separate by currency (e.g. Brazil USD v Brazil EUR v Brazil BRL), and looking at correlations to equities, equities implied vol, and commodities was of little use. - the issuer's "idiosyncratic" spread not correlated to anything except between its own tenors (e.g. IBM 5Y to IBM 10Y)). (It is handy for specific risk add-on.)
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.