Takeover Risk and the Correlation Between Stocks and Bonds

Existing research suggests that, for a given firm, stock returns and changes in bond spreads are negatively related. In this paper, we show how takeover risk influences this relation. Based on a large sample of data covering the period from 1980 to 2000, we find that high-rated firms which are likely to be taken over have a more positive correlation between stock returns and bond spread changes, while target firms with a poison put or an indebtedness covenant have a more negative correlation. Overall, our findings have implications for the pricing and hedging of bonds and default risk based financial products such as credit default swaps