Title

Risk Sharing and the Market for Corporate Control: A Case for Golden Parachutes

Document Type

Article

Publication Date

January 2004

Abstract

The predictability of security returns has received considerable attention in the literature, and yet the predictability of bond returns beyond the US markets has remained far less explored. Here we plan to remedy the shortcoming, and in that effort we analyse the ability of several predetermined information variables in predicting bond returns in the European market. We test if variables, commonly used for that matter in the context of other markets (such as inverse relative wealth, term spread, real bond yield and a January dummy) are also useful predictors of European bond returns. Due to some particularities of the sample period of analysis, characterised by the EMU convergence, we also include the yield spread in relation to German bonds. We further examine the return predictability across different bond maturities: 1-3, 3-5 and 5 or more years to maturity. The results indicate that variables such as the term spread, IRW and a January dummy represent useful information in order to predict bond returns for different maturities. The other two variables add little in terms of explanatory power. Surprisingly, the DM yield spread does not seem to have any predictive ability for the countries expected to participate in the EMU. However, a puzzling result is obtained: this variable appears to be significant for the UK market! Additionally, we find that investors, using simple trading strategies that exploit this information, may obtain higher returns. This outperformance is observed for different maturities, being more evident for long- term Government bonds. These findings may have important implications on other related issues such as market efficiency, asset pricing, and portfolio performance evaluation.

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