Betting on Credit Betas

31 Pages Posted: 31 Jan 2025

See all articles by Lira Mota

Lira Mota

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Tomas Nobrega

Insper Institute of Education and Research

Date Written: December 12, 2024

Abstract

Duration is an important driver of bond return volatility and, consequently, an important driver of market betas. In credit markets, we show that "betting against beta" (BAB) strategy closely resembles a betting against duration strategy. We introduce a new method to estimate conditional betas that more accurately capture the effect of time-varying duration. Our findings reveal that long-short portfolios sorted on duration produce negative alphas, consistent with Frazzini and Pedersen (2014) BAB. However, when controlling for duration, long-short portfolios sorted on beta generate positive alphas of a comparable magnitude. These results are robust to using Treasuries to hedge duration risk. A combined strategy of betting against duration and betting on betas yields a market-orthogonal Sharpe ratio of 1.1, which is almost four times the 0.31 duration hedged market Shape ratio. Leverage constraints alone cannot explain our results.

Suggested Citation

Mota, Lira and Nobrega, Tomas, Betting on Credit Betas (December 12, 2024). Available at SSRN: https://ssrn.com/abstract=5052978 or http://dx.doi.org/10.2139/ssrn.5052978

Lira Mota (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

Tomas Nobrega

Insper Institute of Education and Research ( email )

R Quata 300
Sao Paulo, 04542-030
Brazil

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