Can the Bond Price Reaction to Earnings Announcements Predict Future Stock Returns?
In this paper I show that the bond price reaction to earnings announcements has predictive power for post-announcement stock returns and that it is incremental to previously documented accounting-related anomalies. I find that bonds' predictive ability is driven by non-investment grade bonds, for which earnings releases provide more value-relevant information. It is also stronger in firms with a lower proportion of institutional shareholders and for bonds whose trading is more heavily dominated by sophisticated investors. This suggests that the greater level of investor sophistication in the bond market relative to the stock market is what gives bond returns the ability to predict future stock returns. By demonstrating that a firm's bond price reaction to an earnings announcement can predict future stock returns, this paper adds to the literature which documents that various earnings components also have predictive ability for post-announcement stock returns.