Common Factors in the Performance of European Corporate Bonds – Evidence Before and after Financial Crisis

Abstract

This paper examines common risk factors in Euro-denominated corporate bond returns before and after recent financial crisis. Our results suggest that level and slope of interest rate and default spread term structures significantly improve the explanatory power of asset pricing models for the cross-section of corporate bonds. Further, we demonstrate that corporate bonds with maturities between one and three years continue to yield statistically significant abnormal returns even after controlling for the levels and slopes of interest and default spread term structures. The abnormal returns are up to 151 basis points annually for these short term bonds and are thus of considerable economic interest. The sensitivity of corporate bond returns to interest rate level and slope risk is quite stable over time, whereas the sensitivity to level and slope default risk factors changed during the period of recent financial crisis. Our results are robust to GRS-test, calendar seasonality, and use of alternative risk-free benchmarks.