Corporate Bond Portfolios and Macroeoconomic Conditions

We propose an approach to optimally select corporate bond portfolios based on bond-specific characteristics (maturity, credit rating, coupon, illiquidity, past performance, and issue size) and macroeconomic conditions (recessions and macroeconomic uncertainty measures). The approach relies on a parametric specification of the portfolio weights and allows us to consider a large cross-section of corporate bonds. We find that in periods of low macroeconomic uncertainty, the optimal corporate bond portfolio is tilted toward bonds with longer maturity and higher credit rating (high ex-ante default risk), relative to the benchmark. By contrast, in high macroeconomic uncertainty regimes, the optimal strategy exhibits a flight-to-safety aspect and favors short maturity and relatively low-credit-rating bonds. In all regimes, corporate bonds with high coupons, high past performance, and small size of issuance lead to higher certainty equivalent returns. Overall, we find that the characteristics used in the corporate bond pricing literature to proxy for various sources of risk are also useful in forming corporate bond portfolios. Conditioning on these characteristics and macroeconomic variables leads to a significant improvement in portfolio performance, with the certainty equivalent increasing about 5% per annum after conservative transaction costs. The gain in performance is evenly divided between high and low macroeconomic uncertainty regimes and is not exclusively concentrated in high-yield bonds.