Yields versus Expected Returns of Corporate Bonds: Some Unexpected Results

Posted: 23 Oct 2017

See all articles by Natalia Beliaeva

Natalia Beliaeva

Suffolk University - Department of Finance

Rachel Koh

University of Massachusetts Amherst, Isenberg School of Management, Department of Finance

Sanjay K. Nawalkha

University of Massachusetts Amherst - Isenberg School of Management

Date Written: October 21, 2017

Abstract

We derive expected bond return equations for various structural credit valuation models with alternative stochastic processes and boundary conditions for default given in Merton [1974], Merton [1976], Black and Cox [1976], Heston [1993], Longstaff and Schwartz [1995], and Collin-Dufresne and Goldstein [2001]. We investigate the relationship between bond yields and expected returns under each of these models. We show that for the case of low leverage, bond yields are inversely related to expected returns for a range of maturities that lie beyond the hump of the term structure of bond yields. We also show that for the bonds of same maturity, the option characteristics of the bonds often lead to an inverse relation between bond yields and expected returns. For example, callable bonds have higher yields, but lower expected returns than the corresponding yields and expected returns of the underlying straight bonds. Convertible bonds have higher yields but lower expected returns for the case of high leverage, and lower yields but higher expected returns for the case of low leverage, than the corresponding yields and expected returns of the underlying straight bonds.

Keywords: Bonds, Yields, Expected Returns, Merton, Collin-Dufresne, Callable, Convertible

JEL Classification: G10, G11, G12, G13

Suggested Citation

Beliaeva, Natalia and Koh, Kyungyeon and Nawalkha, Sanjay K., Yields versus Expected Returns of Corporate Bonds: Some Unexpected Results (October 21, 2017). https://doi.org/10.3905/jfi.2018.27.3.037, Available at SSRN: https://ssrn.com/abstract=3056800 or http://dx.doi.org/10.2139/ssrn.3056800

Natalia Beliaeva

Suffolk University - Department of Finance ( email )

8 Ashburton Place-Beacon Hill
Boston, MA 02108-2770
United States

Kyungyeon Koh

University of Massachusetts Amherst, Isenberg School of Management, Department of Finance ( email )

Amherst, MA
United States

Sanjay K. Nawalkha (Contact Author)

University of Massachusetts Amherst - Isenberg School of Management ( email )

Amherst, MA 01003-4910
United States
413-687-2561 (Phone)

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