Abstract
This paper examines the pricing of volatility risk and idiosyncratic volatility in the cross-section of corporate bond returns for the period of 1994–2016. Results show that bonds with high volatility betas have low expected returns, and this negative relation appears in all segments of corporate bonds. Further, bonds with high idiosyncratic bond (stock) volatility have high (low) expected returns, and this relation strengthens as ratings decrease. Conventional risk factors and bond/issuer characteristics cannot account for these cross-sectional relations. There is evidence that the effect of idiosyncratic stock volatility on expected bond returns works through the channel of contemporaneous stock returns.
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