Do Distributional Characteristics of Corporate Bonds Predict their Future Returns?

This paper investigates the significance of volatility, skewness, kurtosis, and downside risk in predicting the cross-sectional variation in future returns on corporate bonds. The results indicate a significantly positive (negative) link between volatility (skewness) and expected returns, whereas kurtosis does not have a robust incremental contribution to the predictability of bond returns. Bonds in the highest volatility quintile generate 6% to 7% more annual raw and risk-adjusted returns compared to bonds in the lowest volatility quintile. After controlling for volatility, bonds with low skewness generate 2.5% to 3% more annual raw and risk-adjusted returns compared to bonds with high skewness. The cross-sectional relation between downside risk and bond returns is even stronger than volatility and skewness. These findings remain intact after controlling for transaction costs, liquidity and a large set of bond characteristics and risk factors. Hence, the distributional characteristics of corporate bonds are powerful determinants of the cross-sectional differences in future returns. This Version: April 2015