Unique Risk-Return Characteristics of High-Yield Bonds

Abstract

As the high-yield (HY) bond market has grown in size and significance, it is important to examine its place in the total capital market and to develop a better understanding of its composition and characteristics. This article considers differences between the investment-grade and the HY bond market, unique characteristics within the HY bond market, and changes in the correlations between asset class sectors and their volatilities over time. There is strong evidence that HY bonds have a very significant equity component that makes them a different asset class from investment-grade bonds. Within the HY bond universe, BB bonds are heavily affected by market interest rates with some equity effect; B-rated bonds have more equity-like characteristics than an interest rate effect; and CCC-rated bonds have virtually no market interest rate effect. There is also clear evidence of changes in correlations among asset classes over time. There have been significant changes in volatility over time, with striking changes duing the 1990–1991 recession, the 1998 Russian credit crisis, and the year 2000 credit crunch. The authors discuss the significant implications of these results for bond analysts and portfolio managers.