Factor Investing with Delays

Abstract

We introduce a novel framework for computing the transaction costs of trading strategies in the infrequently traded corporate bond market. Infrequency leads to delays and missed trading opportunities that reduce the performance of the strategies. Applying this method to a comprehensive library of 341 corporate bond factors from openbondassetpricing.com, we demonstrate that there are large number of factors that outperform the bond market before costs, but not after accounting for delays. Machine learning-based trading strategies that optimally combine the 341 characteristics yield positive bond CAPM alphas even after accounting for bid-ask spreads, but the alphas disappear after accounting for transaction delays. Our results underscore the critical impact of delay costs in illiquid securities and provide valuable insights for factor investing in corporate bond markets.

Keywords: Liquidity, Machine-Learning, Market Efficiency, Fixed-Income Securities, Credit Risk, Corporate bonds, Transaction costs, Factor zoo, Over-the-counter market, Factors, Asset pricing

JEL Classification: G12, G13