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Is there a risk-return tradeoff in the corporate bond market? Time-series and cross-sectional evidence

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  • Bai, Jennie
  • Bali, Turan G.
  • Wen, Quan

Abstract

We provide time-series and cross-sectional evidence on the significance of a risk-return tradeoff in the bond and equity markets. We find a significantly positive intertemporal relation between expected return and risk in the bond market. We also propose novel measures of systematic and idiosyncratic risk for individual corporate bonds and find a significantly positive cross-sectional relation between systematic risk and expected bond returns, whereas there is no significant link between idiosyncratic risk and future bond returns. We provide an explanation for the significance of systematic (idiosyncratic) risk based on different investor preferences and informational frictions in the bond (equity) market.

Suggested Citation

  • Bai, Jennie & Bali, Turan G. & Wen, Quan, 2021. "Is there a risk-return tradeoff in the corporate bond market? Time-series and cross-sectional evidence," Journal of Financial Economics, Elsevier, vol. 142(3), pages 1017-1037.
    • Handle: RePEc:eee:jfinec:v:142:y:2021:i:3:p:1017-1037
    DOI: 10.1016/j.jfineco.2021.05.003
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    More about this item

    Keywords

    Corporate bonds; Systematic risk; Idiosyncratic volatility; Risk-return tradeoff;
    All these keywords.

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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