Do Distributional Characteristics of Corporate Bonds Predict Their Future Returns?

Abstract

We find a significantly positive (negative) relation between volatility (skewness) and the cross-section of corporate bond returns, whereas kurtosis does not make a robust incremental contribution to the predictability of future bond returns. The risk-adjusted return spreads in volatility (skewness) sorted portfolios represent compensation for differences in the level of idiosyncratic volatility (idiosyncratic skewness) and differential exposure to the common idiosyncratic volatility factor in the bond market. We also show that the new risk factors based on the distributional moments of bond returns represent an important source of common return variation missing from the long-established stock and bond market factors.