VIX and corporate bonds

 

There is risk in corporate bonds and this risk can be measured through the VIX market. Equity and bond markets are linked. This should not be surprising since the corporate structure can be divided in equity - the residual value of the firm which is call option and bonds which are a short put option on the firm value. A change in volatility will lead to a change in the value of these options. If the VIX serves as a proxy for equity volatility, then there should be a link with bond spreads which are the added risk above Treasuries for holding corporate bonds.

The authors of an early draft paper, "The VIX as Stochastic Volatility for Corporate Bonds" show that adding the VIX to a time series model of corporate spreads will improve the time series model. First, the residuals of corporate bonds spreads are not Gaussian white noise; however, if you scale the residuals by the VIX to standardize, you will get an improved model. The spikes in spread are dampened when they are scaled by equity market volatility. This is a simple model and test, but it serves as an important improvement over looking at just the simple time series of spreads.