Explaining and Benchmarking Corporate Bond Returns
60 Pages Posted: 5 Jul 2017
Date Written: June 30, 2017
We evaluate how different betas and characteristics related to default, term, and liquidity risk fare against one another in explaining the cross-section of corporate bond returns. We find that characteristics – credit rating, duration, and Amihud illiquidity measure–fare better. Yields add incremental explanatory power. Consistent with yields providing a timelier assessment of default risk than ratings, bonds with higher yields but similar credit ratings, durations and Amihud measures experience more subsequent ratings downgrades, fewer upgrades, and a higher frequency of defaults. Based on our findings, we present characteristic portfolios that can be used to benchmark individual bond and portfolio returns.
Keywords: Corporate bonds, cross-section of returns, credit risk, TRACE, default
JEL Classification: G12, G14
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