Priced risk in corporate bonds

TL;DR

This paper critically examines multifactor models for corporate bond returns, finding that most proposed factors lack incremental explanatory power and challenging the dominance of bond CAPM.

Contribution

It provides a comprehensive reassessment of common bond risk factors, showing their limited ability to explain cross-sectional bond return variations.

Findings

Most proposed bond risk factors do not add explanatory power beyond the market factor.

Traded liquidity is the only marginal exception among the factors.

Bond CAPM is not outperformed by traded- or nontraded-factor models in comparisons.

Abstract

Recent studies document strong empirical support for multifactor models that aim to explain the cross-sectional variation in corporate bond expected excess returns. We revisit these findings and provide evidence that common factor pricing in corporate bonds is exceedingly difficult to establish. Based on portfolio- and bond-level analyses, we demonstrate that previously proposed bond risk factors, with traded liquidity as the only marginal exception, do not have any incremental explanatory power over the corporate bond market factor. Consequently, this implies that the bond CAPM is not dominated by either traded- or nontraded-factor models in pairwise and multiple model comparison tests.