How Do Credit Markets React to Earnings Releases: Empirical Analysis and Implications for Investors

Abstract

Previous studies have found that stock prices incorporate information from earnings announcements only gradually over an extended period. The authors investigate whether credit markets react to the earnings releases in a similar way. They find that issuers with more positive earnings surprises had higher subsequent abnormal bond returns than issuers with more negative surprises after the announcement for several months. The results are not driven by risk compensation or illiquidity; are distinct from the momentum phenomenon; and are evident in all time periods, industries, and credit ratings. The authors also find that index-tracking portfolios that match the IG and HY index key analytics but overweight issuers with positive earnings surprises outperformed the respective index across different market regimes, showing that this market anomaly can be exploited by credit investors in practice.

TOPICS: Portfolio theory, portfolio construction, fixed-income portfolio management, fixed income and structured finance

Key Findings

• • Corporate bond prices move gradually in the same direction as the initial earnings surprises after the announcements for several months and do not mean-revert subsequently.

• • The phenomenon is not driven by illiquidity; is distinct from the momentum effects; and is evident in all time periods, industries, and credit ratings.

• • Index-tracking portfolios that match the IG and HY index key analytics, but overweight issuers with positive earnings surprises outperformed the respective index across different market regimes, showing that this phenomenon can be exploited by credit investors in practice.