Equity Momentum Leads Corporate Bonds
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Strategy in a nutshell
The strategy invests in investment-grade corporate bonds from the Barclays US Corporate Index with tradeable equity tickers, excluding low-priced (<40), high-spread (>20%), or CCC-rated bonds. Monthly credit excess returns are used to adjust for the risk-free rate. Bonds are sorted into quintiles by 3-month trailing equity momentum, going long on the top quintile. The portfolio is value-weighted and rebalanced monthly, using equity momentum as a predictive signal for bond returns.
Economic rationale
Equities typically lead corporate bonds as they price in new information faster. Bond investors react more slowly due to lower volatility and high transaction costs, not liquidity constraints. This difference in information processing makes equity momentum a reliable predictor of corporate bond excess returns.