Articlegreen2023

Modeling Corporate Bond Returns

Bryan Kelly · Diogo Palhares · Seth Pruitt

140 citations0/0 files storedThe Journal of Finance

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Credit Risk and Financial Regulations Financial Markets and Investment Strategies Stochastic processes and financial applications

Abstract

ABSTRACT We propose a conditional factor model for corporate bond returns with five factors and time‐varying factor loadings. We have three main empirical findings. First, our factor model excels in describing the risks and returns of corporate bonds, improving over previously proposed models in the literature by a large margin. Second, our model recommends a systematic bond investment portfolio whose high out‐of‐sample Sharpe ratio suggests that the credit risk premium is notably larger than previously estimated. Third, we find closer integration between debt and equity markets than found in prior literature.

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References

1993Common risk factors in the returns on stocks and bonds 1992The Cross-Section of Expected Stock Returns 1973Risk, Return, and Equilibrium: Empirical Tests 1970Efficient Capital Markets: A Review of Theory and Empirical Work 2014A five-factor asset pricing model 1997Industry costs of equity 2006The Cross‐Section of Volatility and Expected Returns 2001Forecasting Bankruptcy More Accurately: A Simple Hazard Model

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