Editor’s Letter

We begin this issue of The Journal of Fixed Income with an article by Johnny Kang, Tom Parker, Scott Radell, and Ralph Smith that constructs a low risk corporate bond portfolio strategy based on credit safety generated from the Merton credit default model. Their quality and value factors provide an explanation for the cross-section of corporate bond returns and are used to generate significant trading outperformance. In the next article, Michael Howell pursues a detailed analysis of the well-publicized use of the slope of the yield curve to predict the business cycle. Rather than a specific maturity difference, it is the overall pattern of term premium that matters. It appears that the lateral position of the yield curvature is better at predicting recessions than the more popular ones in the financial press.

Compensation for liquidity risk is a component of bond expected returns. After hedging out interest rate risk, Stephen Rush defines the liquidity premium as a function of the ratio of coupon payments after paying for credit protection to realized capital gain. The evidence indicates that the liquidity premium increases, with the time and the way in which investors get compensated for liquidity risk, is more significant than turnover. In the next article, Kenneth Tah and Geoffrey Ngene find support for a ripple effect and the convergence of swap spreads of different maturities. It appears likely that the information flow is responsible for the observed symmetric, highly persistent and time-varying co-movements among pairs of swap spreads.

Limited default observations makes it difficult to evaluate credit risk for illiquid private debt. In the next article, Frédéric Blanc-Brude, Majid Hasan and Timothy Whittaker measure default risk by combining a cash flow structural model with Baysian inference on default. Data on 267 European infrastructure projects over 17 years provide support for their process.

Finally, Mohammadreza Tavakoli Baghdadabad and Girijasankar Mallik provide evidence that the global carry trade (long high interest rates and and short low interest rates) represents the risk premium defined by global co-skewness and global co-kurtosis factors and their hedging characteristics.

We hope you enjoy this issue of The Journal of Fixed Income. Your continued support of the journal is greatly appreciated.

TOPICS: Fixed income and structured finance, fixed-income portfolio management, portfolio theory

Stanley J. Kon

Editor

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