Time-varying risk and return characteristics of US and European bond markets: Implications for efficient portfolio allocation

Abstract

This study examines return volatility among the Swiss, German, UK, and US bond markets by comparing both in-country and US-based returns and risk measures. Our findings include: (1) volatility of in-country bond market returns has been much higher in the US and UK than in Switzerland or Germany; (2) although adding to return volatility, currency returns have generally enhanced overall returns to US-based investors in European bonds; (3) low correlations between US bond market returns and European bond market returns offer potential diversification benefits; (4) overall, the risk per unit of return has been much greater in the US bond market and much lower in the German market than in the Swiss or UK markets; and (5) the risk per unit of return has been much more stable for the Swiss and German bond markets than for the UK or US markets. Our results show that global bond market investors can achieve the greatest efficiency in terms of risk per unit of return by hedging currency risk. The relatively low correlations of returns among these markets afford a global investor the opportunity to improve risk-return efficiency by diversifying among the three markets. This study offers important insights for US-based investors seeking the optimal bond portfolio allocation in risk-return space.