Risk and Return in International Corporate Bond Markets

We investigate risk and return in the major corporate bond markets of the developed world. We find that average returns increase with maturity and ratings class (where ratings go from high to low). From a pricing perspective, we find little to no evidence against the World CAPM model, where the market consists out of equity, sovereign and corporate bonds. However, from a factor model perspective a model, which separates the market portfolio into its three components, fits much more of the corporate bond return variation. In addition, local factors contribute substantially more to the variation of corporate bond returns than do global factors, and a \textquotedblleft local\textquotedblright\ three-factor model explains more than 80\% of the return variation for 59 of 63 portfolios examined. The factor exposures show intuitive patterns; for example as ratings worsen, equity $\beta$'s show a hockey stick pattern, sovereign $\beta$'s decline monotonically and the corporate bond $\beta$'s increase steeply. Our results are robust to the use of hedged versus unhedged returns and are also corroborated by a panel regression at the CUSIP level.