Finding value in the U.S. corporate bond market

67 Pages Posted: 5 Jun 2024

See all articles by Liuren Wu

Liuren Wu

City University of New York, Baruch College - Zicklin School of Business - Department of Economics and Finance

Hashim Zaman

Harvard Business School

Date Written: June 03, 2024

Abstract

This paper identifies value-investing opportunities in the U.S. corporate bond market through the joint construction of a bond valuation model and a return factor model. The valuation model explains the cross-sectional corporate bond yield variation with a flexible functional form in bond risk characteristics including bond duration, credit rating, historical yield change volatility, bond liquidity, and the optionality-induced yield spread adjustment for callable bonds. The return factor model embeds the residual from the valuation model as a mispricing factor while capturing the stronger co-movements between bonds from the same industry, similar rating classes, and similar duration segments, and accounting for differential pricing of bond return risk, liquidity cost, and the optionality exposure. Historical analysis over the past two decades shows that the valuation model can explain the cross-sectional bond yield variation very well, and the value-investing portfolio constructed from the return factor model generates highly positive average excess returns with low risk.

Keywords: bond yields, credit risk, duration risk, historical volatility, liquidity cost, optionality, mispricing, value investing

Suggested Citation

Wu, Liuren and Zaman, Hashim, Finding value in the U.S. corporate bond market (June 03, 2024). Available at SSRN: https://ssrn.com/abstract=4852548 or http://dx.doi.org/10.2139/ssrn.4852548

Liuren Wu (Contact Author)

City University of New York, Baruch College - Zicklin School of Business - Department of Economics and Finance ( email )

One Bernard Baruch Way
Box B10-247
New York, NY 10010
United States

HOME PAGE: http://sites.google.com/view/liurenwu

Hashim Zaman

Harvard Business School ( email )

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