Modeling Corporate Bond Returns

45 Pages Posted:

See all articles by Bryan T. Kelly

Bryan T. Kelly

Yale SOM; AQR Capital Management, LLC; National Bureau of Economic Research (NBER)

Diogo Palhares

AQR Capital Management, LLC

Seth Pruitt

Arizona State University (ASU) - Finance Department

Date Written: October 28, 2020

Abstract

We propose a new conditional factor model for returns on corporate bonds. The model has four factors with time-varying factor loadings that are instrumented by observable bond characteristics. We have three main empirical findings. The first is that our factor model excels in describing the risks and returns of corporate bonds, improving over previously proposed models in the literature by a large margin. Second, using bond characteristics to instrument evolving bond risk exposures significantly improves not only our model, but also previously proposed models of observable corporate bond factors. Third, our no-arbitrage model recommends a systematic bond investment portfolio that significantly outperforms leading corporate credit investment strategies. However, also we find that a ``pure alpha'' bond portfolio---which is orthogonal to factor risk---is incrementally profitable when combined with the no-arbitrage strategy.

Keywords: corporate bond, factor model, bond portfolio, credit risk, IPCA

JEL Classification: G10, G11, G12

Suggested Citation

Kelly, Bryan T. and Palhares, Diogo and Pruitt, Seth, Modeling Corporate Bond Returns (October 28, 2020). Available at SSRN: https://ssrn.com/abstract=

Bryan T. Kelly (Contact Author)

Yale SOM ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Diogo Palhares

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

Seth Pruitt

Arizona State University (ASU) - Finance Department ( email )

W. P. Carey School of Business
PO Box 873906
Tempe, AZ 85287-3906
United States

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
72
Abstract Views
267
PlumX Metrics