Total Return and Credit Spread Diversification in International Bond Portfolios

Abstract

In this study we investigate the factors responsible for diversification in international corporate bond portfolios. We observe that interest rate factors are the most important single cause of diversification of total portfolio returns. Maturity diversification follows as the second most effective risk reduction strategy, while credit rating and seniority diversification effects are unimportant. Interest rate and maturity diversification are also found to be the dominant strategies to reduce the volatility of credit spreads. Finally, contrary to recent evidence from the stock market, industry diversification produces but a negligible impact on the volatility of corporate bond portfolios.