Stocks versus corporate bonds: A cross-sectional puzzle

We study the cross-sectional relation between stock and corporate bond markets. By correcting credit spreads of corporate bonds for expected default losses and by using equity-bond elasticities, we obtain a firm's expected bond-implied stock return, which we then compare to its realized stock return. We find, surprisingly, a strong negative cross-sectional relation between these expected and realized stock returns. We show that this effect is not simply a restatement of the distress risk puzzle or other well-known anomalies in stock and corporate bond markets. This negative cross-sectional relation is strongest for high-risk firms and for liquid stocks.