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Reaching for Yield and the Cross Section of Bond Returns

Author

Listed:
  • Qianwen Chen

    (Department of Risk Management, Bank of Communications, Shanghai 200120, China)

  • Jaewon Choi

    (Department of Finance, University of Illinois Urbana-Champaign, Champaign, Illinois 61820; Department of Economics, Seoul National University, Seoul, Korea)

Abstract

Reaching for yield, which we define as an investor preference for higher-yield bonds at a given rating or for higher-rated bonds at given yields, is associated with inflated valuation and thus negatively predicts risk-adjusted returns. Controlling for ratings, alphas are lower for higher-yield bonds, whereas, controlling for yields, alphas are lower for safer-looking, higher-rated bonds. Future bond returns are particularly low when current interest rates are low and demand from yield-reaching investors increases. These bonds experience more frequent downgrades and defaults, suggesting that they are riskier despite their high valuation.

Suggested Citation

  • Qianwen Chen & Jaewon Choi, 2024. "Reaching for Yield and the Cross Section of Bond Returns," Management Science, INFORMS, vol. 70(8), pages 5226-5245, August.
    • Handle: RePEc:inm:ormnsc:v:70:y:2024:i:8:p:5226-5245
    DOI: 10.1287/mnsc.2023.4920
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