Corporate Bond Returns Research Articles

Behavioral biases in the corporate bond market

This paper investigates the behavioral biases in the corporate bond market through the cross-section association between retail and institutional trades and corporate bond returns. The study finds that bonds heavily bought by retail investors in one month underperform in the next month relative to bonds heavily sold, and the opposite holds for institutional investors. The alpha of the high-low portfolio (formed based on decile sorting on the buy–sell trade imbalance) relative to the usual market factors is significant for retail investors, but insignificant for institutional investors. The overall results indicate that retail investors in the corporate bond market suffer from behavioral biases but institutional investors do not. However, when the spread between the purchase and sell prices is factored into the returns, no profitable trading strategies exist, consistent with limits to arbitrage.

Yields versus Expected Returns of Corporate Bonds: Some Unexpected Results

We derive expected bond return equations for various structural credit valuation models with alternative stochastic processes and boundary conditions for default given in Merton [1974], Merton [1976], Black and Cox [1976], Heston [1993], Longstaff and Schwartz [1995], and Collin-Dufresne and Goldstein [2001]. We investigate the relationship between bond yields and expected returns under each of these models. We show that for the case of low leverage, bond yields are inversely related to expected returns for a range of maturities that lie beyond the hump of the term structure of bond yields. We also show that for the bonds of same maturity, the option characteristics of the bonds often lead to an inverse relation between bond yields and expected returns. For example, callable bonds have higher yields, but lower expected returns, than the corresponding yields and expected returns of the underlying straight bonds. Convertible bonds have higher yields but lower expected returns for the case of high leverage, and lower yields but higher expected returns for the case of low leverage, than the corresponding yields and expected returns of the underlying straight bonds.

Good and Bad Variance Premia and Expected Returns

We measure “good” and “bad” variance premia that capture risk compensations for the realized variation in positive and negative market returns, respectively. The two variance premium components jointly predict excess returns over the next one and two years with statistically significant positive (negative) coefficients on the good (bad) component. The R2s reach about 10% for aggregate equity and portfolio returns and 20% for corporate bond returns. To explain the new empirical evidence, we develop a model that highlights the differential impact of upside and downside risk on equity and variance risk premia. The online appendix is available at https://doi.org/10.1287/mnsc.2017.2890 . This paper was accepted by Neng Wang, finance.

Risk Taking and Corporate Bond Financing Costs:Strategic Adjustment Perspective Based on Credit Rating

The companies' risk taking significantly affects the credit rating, thereby affecting the corporate bond issuance eligibility and financing costs, so the companies issuing bonds have the motive for the adjustment to risk taking strategy based on rating. This paper examines the changes in risk taking before the initial credit rating, and tests the influence of risk taking on the initial credit rating and its market reaction. The empirical results show that, before obtaining the initial credit rating, a firm's risk taking continues to decline, and then rises slowly, indicating that the companies adjust risk taking to cater to the rating demand; risk taking and the main credit rating are negatively correlated; through the intermediary effect of credit rating, the risk taking is significantly positively correlated with the costs of bond financing. The companies can obtain the ideal main credit rating by tactfully adjusting the risk taking, and thereby achieve effective saving of the financing costs.

Momentum lost and found in corporate bond returns

In this paper, we propose an overreaction detection method to capture price reversals in the momentum cycle. Motivated by the absence of the momentum effect in investment-grade (IG) bonds, which is uncommon for most financial assets, we verify the method by showing significant improvements in the refined momentum portfolios of U.S. IG bonds from January 1994 to June 2014. The subsample of private or public firms and the relation to investor sentiment also indicate price momentum for both non-investment-grade (NIG) bonds and IG bonds. Our results carry important consistency implications for price continuations across financial assets and markets.

Debt Composition and Lax Screening in the Israel Corporate Bond Market

Corporate bond markets may suffer from investors’ lack of competence in screening out low-quality issuers. We use data from the Israeli capital market in 1999-2009 to investigate the quality of corporate bond issuers and the role of the institutional investors in the screening process in the corporate bond market. The findings suggest that higher quality firms were more likely to issue bonds, but firms of lower quality tended to raise a higher fraction of their debt through bond issuance. Firms with higher proportion of their debt in bonds out had also a higher tendency to default. Institutional investors intensively funded firms with higher share of bonds in their long-term debt despite their lower quality, and therefore were partially responsible for the lax screening in the corporate bond market.

Debt composition and lax screening in the corporate bond market

Corporate bond markets may suffer from investors’ lack of competence in screening out low-quality issuers. We use data from the Israeli capital market in 1999–2009 to investigate the quality of corporate bond issuers and the role of the institutional investors in the screening process in the corporate bond market. The findings suggest that higher quality firms were more likely to issue bonds, but firms of lower quality tended to raise a higher fraction of their debt through bond issuance. Firms with higher proportion of their debt in bonds out had also a higher tendency to default. Institutional investors intensively funded firms with higher share of bonds in their long-term debt despite their lower quality, and therefore were partially responsible for the lax screening in the corporate bond market.

Yields versus Expected Returns of Corporate Bonds: Some Unexpected Results

We derive expected bond return equations for various structural credit valuation models with alternative stochastic processes and boundary conditions for default given in Merton [1974], Merton [1976], Black and Cox [1976], Heston [1993], Longstaff and Schwartz [1995], and Collin-Dufresne and Goldstein [2001]. We investigate the relationship between bond yields and expected returns under each of these models. We show that for the case of low leverage, bond yields are inversely related to expected returns for a range of maturities that lie beyond the hump of the term structure of bond yields. We also show that for the bonds of same maturity, the option characteristics of the bonds often lead to an inverse relation between bond yields and expected returns. For example, callable bonds have higher yields, but lower expected returns than the corresponding yields and expected returns of the underlying straight bonds. Convertible bonds have higher yields but lower expected returns for the case of high leverage, and lower yields but higher expected returns for the case of low leverage, than the corresponding yields and expected returns of the underlying straight bonds.

Granularity of Corporate Debt

We study whether firms spread out debt maturity dates, which we call of corporate debt.'' In our model, firms that are unable to roll over expiring debt need to liquidate assets. If multiple small asset sales are less inefficient than a single large one, it can be optimal to diversify debt rollovers across time. Using a large sample of corporate bond issuers during the 1991-2012 period, we establish novel stylized facts and evidence consistent with our model's predictions. There is substantial heterogeneity, i.e., firms have both concentrated and dispersed debt structures. Debt maturities are more dispersed for larger and more mature firms, for firms with better investment opportunities, with higher leverage, and with lower profitability. During the recent financial crisis firms with valuable investment opportunities implemented more dispersed maturity structures. Finally, firms manage granularity actively and adjust toward target levels.

Equity cross-listings in the U.S. and the price of debt

Using a large panel from 46 countries over 20 years, we find that non-U.S. firms issue corporate bonds more frequently and at lower offering yields following an equity cross-listing on a U.S. exchange. Firms issue more bonds through public offerings instead of private placements and in foreign markets rather than at home, in both cases at significantly lower yields. Moreover, the debt-related benefits are concentrated among firms domiciled in countries with less private benefits of control, efficient debt enforcement, and developed bond markets, suggesting that equity cross-listings cannot completely offset the impact of weak home country institutions. The results support the notion that the monitoring, transparency, and visibility benefits brought about by equity cross-listings on U.S. exchanges are valuable to bond investors.

Comoment Risk in Corporate Bond Yields and Returns

This paper provides a comoment factor analysis of corporate bond returns using sector index bond portfolios. Corporate bond excess default return are decomposed into systematic default risk premiums rewarding investors for exposure to default risk and net excess returns adjusting for actual market conditions. Higher order comoments contribute positively to systematic default risk premiums. Furthermore, covariance and cokurtosis lower net excess returns as they trigger more value losses. We show a gradual substitution effect between covariation and tail risk contributions to the systematic risk premium for higher maturities, indicating a shift from the pricing of downgrading to outright default risk.

Reach for Safety

In the corporate bond market, investor propensity to reach for yield creates an opportunity for factor-based investors to “reach for safety” following an economic intuition that parallels low-risk factor investing in equities. Given this insight, we motivate a measure of credit safety based on the Merton (1974) distance-to-default variable, which we use to define quality and value factors. We demonstrate that both factors help explain the cross-section of corporate bond returns in an uncorrelated and complementary manner. Since these factors have performed particularly well in their bottom quintiles, we demonstrate how they can be used as screens within long-only portfolios. In addition, we show how incorporating our quality and value insights in a long-only optimization setup can generate significant outperformance net of estimated transaction costs versus traditional value-weighted market portfolios.

Share Buybacks, Monetary Policy and the Cost of Debt

Share buybacks have become common practice across U.S corporations. This paper shows that firms finance these operations mostly through newly issued corporate bonds, and that the exogenous variation in the cost of debt – due to innovations in monetary policy – is key in explaining managers’ incentives to repurchase their own shares. Under our identification strategy, we find that firms are more likely to repurchase in periods of accommodating monetary policy when the yield on bond adjusts in the same direction. This behavior has macroeconomic implications as it exacerbates the crowding-out effect on investment and employment, thus reducing the transmission of monetary policy at establishment level.

Good and Bad Variance Premia and Expected Returns

We measure and bad variance premia that capture risk compensations for the realized variation in positive and negative market returns, respectively. The two variance premium components jointly predict excess returns over the next 1 and 2 years with statistically significant positive (negative) coefficients on the good (bad) component. The R2s reach about 10% for aggregate equity and portfolio returns, and 20% for corporate bond returns. To explain the new empirical evidence, we develop a model that highlights the differential impact of upside and downside risk on equity and variance risk premia.

Is the Cross-Section of Expected Bond Returns Influenced by Equity Return Predictors?

A significant fraction of firms' financing occurs via public debt markets. Accordingly, we investigate whether financial statement characteristics and other variables that predict equity returns also predict corporate bond returns. Profitability, asset growth, and equity market capitalization negatively predict corporate bond returns, but other predictors, like accruals and earnings surprises, do not. Since smaller, unprofitable firms should be more risky, and firms with high asset growth (or high real investment) should have lower required returns, the evidence indicates that corporate bond returns accord with the risk-reward paradigm. Stock markets lead bond markets, consistent with equities aggregating diverse information and transmitting it to bonds. Overall, we find that accounting for transaction costs, bonds are efficiently priced.

Are Capital Market Anomalies Common to Equity and Corporate Bond Markets? An Empirical Investigation

Corporate bond returns exhibit predictability in a manner consistent with efficient pricing. Many equity characteristics, such as accruals, standardized unexpected earnings, and idiosyncratic volatility, do not impact bond returns. Profitability and asset growth are negatively related to corporate bond returns. Because firms that are profitable or have high asset growth (and hence more collateral) should be less risky, with lower required returns, the evidence accords with the risk–reward paradigm. Past equity returns are positively related to bond returns, indicating that equities lead bonds. Cross-sectional bond return predictors generally do not provide materially high Sharpe ratios after accounting for trading costs.

Explaining and Benchmarking Corporate Bond Returns

We evaluate how different betas and characteristics related to default, term, and liquidity risk fare against one another in explaining the cross-section of corporate bond returns. We find that characteristics – credit rating, duration, and Amihud illiquidity measure–fare better. Yields add incremental explanatory power. Consistent with yields providing a timelier assessment of default risk than ratings, bonds with higher yields but similar credit ratings, durations and Amihud measures experience more subsequent ratings downgrades, fewer upgrades, and a higher frequency of defaults. Based on our findings, we present characteristic portfolios that can be used to benchmark individual bond and portfolio returns.

Bonds and restructurings: corporate bond considerations in the design of debt restructuring frameworks in emerging market economies

The design of corporate debt restructuring frameworks requires careful attention. However, the existing literature is extremely limited in its coverage of considerations relating specifically to the restructuring of corporate bonds. Issuance of corporate bonds by firms in emerging market economies has expanded significantly in recent years, and restructurings dealing with such bonds are likely to be much more numerous in the future. In this light, the article first outlines key features of corporate bonds, and discusses the nature of engagement with bondholders as a stakeholder group in the restructuring context. It then sets out considerations regarding the design of restructuring frameworks in emerging market economies relating to corporate bonds, explaining their importance in the design of such frameworks.

Editor’s Letter

1. Stanley J. Kon 1. Editor <!-- --> 1. To order reprints of this article, please contact Dewey Palmieri at dpalmieri{at}iijournals.com or 212-224-3675. Portfolio managers are certainly aware of the left tail risk in the distribution of corporate bond returns, but traditional measures of

Underwriter Distress and Rollover Risk

We show that corporate bond issuers benefit from utilizing existing underwriter relationships when rolling over bonds, but at the same time become exposed to underwriter distress. A strong relationship enables the underwriter to credibly certify the issuer resulting in lower direct issuance costs and lower underpricing. However, if the underwriter becomes distressed, this spills over to the issuer's credit risk, because it weakens the relationship and increases the risk of involuntary relationship termination. The credit risk spillover is more pronounced for risky, opaque issuers with high rollover exposure, i.e., those issuers most in need of certification by an underwriter.