Credit Risk Factor in Bonds

Which Factors for Corporate Bond Returns?

AuthorsMebane

Paper linkhttps://papers.ssrn.com/sol3/papers.cfm?abstract_id=4012601

This strategy trades U.S. corporate bonds using TRACE Enhanced data. Bonds are filtered and sorted by credit rating, then bivariate-sorted on downside risk, illiquidity, and short-term return reversal. The three components are equally weighted to construct the overall credit risk factor.

Credit risk explains cross-sectional bond returns and is well-priced in the market. Downside risk, illiquidity, and short-term reversal all positively predict returns, and the Bayesian approach ensures the most informative factor combination is selected.