Capital Structure Priority Effects in Durations, Stock-Bond Comovements, and Factor Pricing Models

We show theoretically and empirically that the durations of corporate securities are monotonically related to their capital structure priority, with equity often having a negative duration. The magnitude of this effect increases with firm leverage. We use these insights to challenge existing results on stock-bond comovements and factor pricing. For example, though overlooked, higher leverage and lower priority reduce the correlation between corporate security and government bond returns, and these variables explain time-series and cross-sectional variation in correlations; traditional market model regressions significantly understate corporate bond betas; and regressions on standard term and default factors dramatically overstate interest rate and default risk. (JEL G12, G13) Received November 22, 2019; editorial decision October 18, 2021 by Editor Jeffrey Pontiff. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.