Benchmarking Individual Corporate Bonds

34 Pages Posted: 12 Oct 2021 Last revised: 13 Oct 2021

See all articles by Xin He

Xin He

City University of Hong Kong (CityU) - College of Business

Guanhao Feng

City University of Hong Kong (CityU)

Junbo Wang

Dept. of Economics and Finance, City Univ. of HK

Chunchi Wu

SUNY at Buffalo - School of Management

Date Written: June 30, 2021

Abstract

We propose an alternative approach to the linear factor model to estimate and decompose asset risk premia in empirical asset pricing. To resolve the high-dimensional sort difficulty in forming characteristic-based benchmark portfolios, we introduce a benchmark combination model (BCM) that combines multiple basis portfolios as the pricing kernel. With a non-arbitrage objective, our approach minimizes cross-sectional pricing errors and identifies the sources of risk through the combination of basis portfolios. For a 40-year sample for U.S. corporate bonds, we find that BCM outperforms standard factor models in pricing corporate bonds. Second, our study shows that credit ratings, downside risk, and short-term reversal are primary sources of bond risk premia. Finally, incorporating machine learning forecasts into the BCM, we find strong evidence of return predictability.

Keywords: Characteristic-based portfolios, high-dimensional sort, corporate bond risk premia, forecast combination, machine learning, return predictability

JEL Classification: C1, G1

Suggested Citation

He, Xin and Feng, Guanhao and Wang, Junbo and Wu, Chunchi, Benchmarking Individual Corporate Bonds (June 30, 2021). Available at SSRN: https://ssrn.com/abstract=3940817

Xin He (Contact Author)

City University of Hong Kong (CityU) - College of Business ( email )

83 Tat Chee Avenue
Academic Building (LAU)
Kowloon Tong, 12200
Hong Kong

Guanhao Feng

City University of Hong Kong (CityU) ( email )

83 Tat Chee Avenue
Kowloon Tong
Hong Kong

Junbo Wang

Dept. of Economics and Finance, City Univ. of HK ( email )

83 Tat Chee Ave., Kowloon Tong
Kowloon Town
Kowloon, 220
Hong Kong
34429492 (Phone)
852-2788-8806 (Fax)

Chunchi Wu

SUNY at Buffalo - School of Management ( email )

Jacobs Management Center
Buffalo, NY 14222
United States

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