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Can an equity structure dominate the risk-return profile of corporate bonds?

Author

Listed:
  • Edouard Nouvellon

    (Université Libre de Bruxelles)

  • Hugues Pirotte

    (Université Libre de Bruxelles)

Abstract

In a very low interest rate and tight credit spread environment, institutional investors look for alternatives to enhance their fixed income portfolios whilst maintaining their risk profile. Some have devised hedge funds as a solution to improve return at comparable risk levels. More recently, some authors show that appropriate optional strategies could offer better risk-return profiles than hedge funds. This paper proposes a synthetic equity derivative structure that mimics the cash flow behaviour of a corporate bond portfolio. Both alternatives are empirically compared, balancing their yield with their level of risk, and integrating the probability of default. In the case of the high-rating class, our results show that the derivative structure offers a better “spread-default” profile than that of corporate bonds. This may have interesting implications for insurers and pension funds that seek to invest a substantial fraction of their portfolio in high-grade fixed income assets and is consistent with the focus of liability-driven investors on yearly cash flow requirements.

Suggested Citation

  • Edouard Nouvellon & Hugues Pirotte, 2021. "Can an equity structure dominate the risk-return profile of corporate bonds?," Journal of Asset Management, Palgrave Macmillan, vol. 22(4), pages 277-290, July.
  • Handle: RePEc:pal:assmgt:v:22:y:2021:i:4:d:10.1057_s41260-021-00213-5
    DOI: 10.1057/s41260-021-00213-5
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    References listed on IDEAS

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    1. Yu, Wayne W. & Lui, Evans C.K. & Wang, Jacqueline W., 2010. "The predictive power of the implied volatility of options traded OTC and on exchanges," Journal of Banking & Finance, Elsevier, vol. 34(1), pages 1-11, January.
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    3. John Y. Campbell & Glen B. Taksler, 2003. "Equity Volatility and Corporate Bond Yields," Journal of Finance, American Finance Association, vol. 58(6), pages 2321-2350, December.
    4. Chen, Yong, 2011. "Derivatives Use and Risk Taking: Evidence from the Hedge Fund Industry," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 46(4), pages 1073-1106, August.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Equity derivatives; Synthetisation; Market continuum; Corporate bonds; Rating; Probability of default;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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