THE EFFECT OF IDIOSYNCRATIC AND SYSTEMATIC STOCK VOLATILITY ON BOAD RATES AND YIELDS

This paper uses Fama-French and Carhart Four-factor Model to compute systematic risk andidiosyncratic risk for firm’s equity risk. It then assesses these two equity risk components tobond credit rating and bond yield. The analysis is conducted by applying a multivariateregression model on a universe of US equity and bond data over the last ten years from 2007 to2016. Our research shows that idiosyncratic risk is an important determinant of both bond ratingand yield. Interestingly, while systematic risk seems not to affect the rating, it seems to be animportant determinant for bond yields. For low credit rating bonds, yields are mainly driven byidiosyncratic risk; but for high rating bonds, systematic risk is just as important (and sometimeseven more important than) as the idiosyncratic risk. Additionally, this relationship varies with theeconomic condition; for example, the systematic risk was not an important factor during thefinancial crisis period of 2007-2010.