A methodology for computing and comparing implied equity and corporate-debt Sharpe Ratios

A methodology for computing and comparing implied equity and corporate-debt Sharpe Ratios This paper presents a macro-economic methodology for evaluating the forward-looking Sharpe Ratios of the equity and debt components of the United States public company capital structure. Using this framework, it is shown that the equity and debt Sharpe Ratios are both time variant and disparate. The methodology is used to review the risk aversion behavior of equity and debt market participants surrounding the past three major market events, the 1987 crash, the 2000–2001 Internet bubble and the 2008–2009 credit crisis. The forward-looking Sharpe Ratios are used to construct a dynamic portfolio of stocks and corporate bonds that outperforms a static portfolio on a risk-adjusted basis. This paper then offers market segmentation and the differing behavior of equity and corporate bond investors as an explanation for the observed Sharpe Ratios. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Review of Quantitative Finance and Accounting Springer Journals

A methodology for computing and comparing implied equity and corporate-debt Sharpe Ratios

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Publisher
Springer US
Copyright
Copyright © 2013 by Springer Science+Business Media New York
Subject
Economics / Management Science; Finance/Investment/Banking; Accounting/Auditing; Econometrics; Operations Research/Decision Theory
ISSN
0924-865X
eISSN
1573-7179
D.O.I.
10.1007/s11156-013-0424-2
Publisher site
See Article on Publisher Site

Abstract

This paper presents a macro-economic methodology for evaluating the forward-looking Sharpe Ratios of the equity and debt components of the United States public company capital structure. Using this framework, it is shown that the equity and debt Sharpe Ratios are both time variant and disparate. The methodology is used to review the risk aversion behavior of equity and debt market participants surrounding the past three major market events, the 1987 crash, the 2000–2001 Internet bubble and the 2008–2009 credit crisis. The forward-looking Sharpe Ratios are used to construct a dynamic portfolio of stocks and corporate bonds that outperforms a static portfolio on a risk-adjusted basis. This paper then offers market segmentation and the differing behavior of equity and corporate bond investors as an explanation for the observed Sharpe Ratios.

Journal

Review of Quantitative Finance and AccountingSpringer Journals

Published: Dec 4, 2013

References

  • The informational efficiency of the equity market as compared to the syndicated loan market
    Allen, L; Gottesman, A
  • By force of habit: a consumption-based explanation of aggregate stock market behavior
    Campbell, JY; Cochrane, JH

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