Common Risk Factors in the Cross-Section of Corporate Bond Returns

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We investigate the cross-sectional determinants of corporate bonds and find that downside risk is the strongest predictor of future bond returns. We also introduce common risk factors based on the prevalent risk characteristics of corporate bonds – downside risk, credit risk, and liquidity risk – and find that these novel bond market factors have economically and statistically significant risk premia, which cannot be explained by the long-established stock and bond market factors. We further show that these newly proposed risk factors outperform all other models considered in the literature in explaining the returns of the industry-sorted and size/maturity-sorted portfolios of corporate bonds.