Abstract
In contrast to earlier decades, since the early 2000s, the average idiosyncratic volatility of stocks has fallen back to its pre-1990s level. Here, we examine whether decreasing volatility still helps to explain the cross-sectional variation of bond returns. Using a panel data of corporate bond returns spanning July 2002 to June 2016, we find that the average bond returns and lag idiosyncratic volatility are positively associated. The average returns on bonds with high sensitivities to average idiosyncratic volatilities exceed bonds with low sensitivities by about 2.4% for financial firms and 1.5% for nonfinancial firms. The positive association is robust when we control for size, bond ratings, leverage ratio, and bond maturity as well as the effects of default spread, term spread, and liquidity spread. The results suggest that idiosyncratic volatility is still an important factor in explaining the cross-sectional variation of average bond returns.
Published Version
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