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High-yield versus investment-grade bonds: less risk and greater returns?

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Listed:
  • Hsi Li
  • Joseph McCarthy
  • Coleen Pantalone

Abstract

Using Bank of America/Merrill Lynch bond yield indexes, we compare the returns on investment-grade bonds to the returns on high-yield bonds over the period from January 1997 through mid-August 2011, a period marked by the collapse of the technology sector in early 2000 and the financial crisis in 2008. We compare return and risk measures under the assumption of a normal distribution with those obtained under the assumption of a stable distribution. When a normal distribution is assumed, we see a higher expected return associated with a lower SD on the high-yield bond returns relative to investment-grade bond returns. However, we also find that the returns on both high-yield bonds and investment-grade bonds exhibit stable (fat-tailed) distributions, with the fat tail more pronounced for the high-yield bond series. These results suggest that the assumption of a distribution that allows for fat tails and skewness is important for identifying the risk and return characteristics of these bond series.

Suggested Citation

  • Hsi Li & Joseph McCarthy & Coleen Pantalone, 2014. "High-yield versus investment-grade bonds: less risk and greater returns?," Applied Financial Economics, Taylor & Francis Journals, vol. 24(20), pages 1303-1312, October.
  • Handle: RePEc:taf:apfiec:v:24:y:2014:i:20:p:1303-1312
    DOI: 10.1080/09603107.2014.925049
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