Betting on Credit Betas
31 Pages Posted: 31 Jan 2025
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.
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