Corporate Bond Elasticities : Substitutes Matter

We construct exogenous demand shocks using quarterly mutual fund flow data to estimate CUSIP and portfolio elasticities for U.S. corporate bonds. Our approach relaxes the homogeneous cross-elasticity assumption implicitly embedded in many existing methods. At the CUSIP level, the elasticity is around 25, suggesting bonds are considerably more elastic than stocks. While individual bonds are highly elastic, aggregated portfolios of bonds are not---rating-level portfolio's have elasticities as low as 0.2. Generally, demand elasticity is negatively related to the level of aggregation. We also find that demand is more elastic in the long run, with the price impact taking around three to four quarters to fully revert. Turning to heterogeneity in elasticities, we find high-yield and long-term bonds are more inelastic than investment-grade and short-term bonds. Furthermore, the sharp change in inelasticity around the IG/HY cut-off suggests that investor segmentation may be a source of demand inelasticity. Finally, we find difficult-to-replicate portfolios have more inelastic demand, consistent with greater arbitrage risk being a source of inelasticity. Overall, our findings contribute to understanding the key drivers of inelastic markets