Reversal effect and corporate bond pricing in China

Abstract

This paper documents significant price reversal in Chinese corporate bonds using transaction data from 2008 to 2018. We contribute to the existing literature by constructing a reversal factor and proposing a new corporate bond pricing model. Corporate bonds generating lower returns in the past months outperform those generating higher past returns. The reversal profits are strongest in portfolios with around 9-month formation period and disappear when the formation period reaches 12 months. After controlling for bond rating, maturity, turnover, and trading volume, the reversal effects remain significant. We construct a reversal factor and propose a four-factor model by incorporating the new factor into the default-term two-factor bond pricing model plus the bond market factor. The proposed four-factor model captures systematic risk and reversal effect well and makes a significant marginal contribution to explaining the excess return of corporate bond portfolios.