Exploiting Uncertainty with Market Timing in Corporate Bond Markets

Abstract

The purpose of this article is to show the usefulness of technical analysis in credit markets. We document that an application of a simple moving average timing strategy to U.S. high yield and U.S. investment grade corporate bond portfolios sorted by option-adjusted spread generates investment timing portfolios that substantially outperform the corresponding benchmark. For portfolios with high uncertainty, as measured by the option-adjusted spread, the abnormal returns generate economically and statistically significant returns relative to the capital asset pricing model (CAPM), the Carhart 4-factor model and additionally the bond factor model from Asness et al. (2013). Our results remain robust to different moving average formation periods, transaction costs, long-short portfolio construction techniques and alternative definitions of information uncertainty.

Keywords: Market efficiency, market timing, predictability, behavioral finance, technical analysis

JEL Classification: G11, G12, G14