A Conditional Variance Model of Corporate Bond Excess Return Distributions

Abstract

The author presents a model that addresses the dynamic and asymmetric nature of corporate bond excess return distributions. The model forecasts the distribution of monthly corporate bond excess returns conditional on credit spreads, spread duration, and market share. Relative to an approach based on credit ratings, the distribution of standardized residuals of the conditional variance model more closely approaches the standard normal distribution. Over time the model accurately forecasts changes in corporate bond volatility and reflects cross-sectional differences in the volatility of bond cohorts defined by credit rating, industry, and maturity. U.S. investment grade corporate bonds are the focus of the analysis, but the author also presents results for a high yield model.

TOPICS: Fixed income and structured finance, volatility measures