Is There a Risk-Return Tradeoff in the Corporate Bond Market? Time-Series and Cross-Sectional Evidence

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.

Keywords: corporate bonds, systematic risk, idiosyncratic volatility, risk-return tradeoff.

JEL Classification: C13, G10, G11

Suggested Citation: Suggested Citation

Bai, Jennie and Bali, Turan G. and Wen, Quan, Is There a Risk-Return Tradeoff in the Corporate Bond Market? Time-Series and Cross-Sectional Evidence (October 14, 2020). Journal of Financial Economics, Forthcoming, Georgetown McDonough School of Business Research Paper No. 3401231, Available at SSRN: https://ssrn.com/abstract=3401231 or http://dx.doi.org/10.2139/ssrn.3401231