The Risks and Returns of Corporate Loans
33 Pages Posted: 3 Dec 2014
Date Written: December 1, 2014
We study the risks and returns of syndicated corporate loans, which have become an actively managed asset class due to the emergence of nonbank institutional investors. We show that the returns to corporate loans have slightly negative interest rate duration and time-varying exposure to default risk. We estimate a regime switching model and show that shocks to default risk have a large impact on loan returns when leverage is high and a much smaller impact on loan returns when leverage is low, consistent with standard models of credit risk pricing. As a result, the systematic risk exposure of corporate loans increases following negative shocks to returns and decreases following positive shocks. This result has implications for portfolio allocation decisions, performance attribution, investor capital structure, and all other investment decisions that depend on the risks of the asset class.
Keywords: Bank loans, fixed income, default risk, collateralized loan obligation, time varying risk
JEL Classification: G12, G21, G23, G32
Suggested Citation: Suggested Citation