Published Papers

Priced risk in corporate bonds

joint with Philippe Mueller (Warwick Business School) and Cesare Robotti (Warwick Business School), Journal of Financial Economics, Volume 150, Issue 2, November 2023 (Selected as the Editor's Choice for the November 2023 volume of the Journal of Financial Economics)

Abstract:

Recent studies document strong empirical support for factor models that aim at explaining the cross-sectional variation in corporate bond returns. We revisit these results and provide evidence that common factor pricing in corporate bonds is exceedingly difficult to establish. Based on returns in excess of the one-month Treasury bill rate, we demonstrate that previously proposed corporate bond risk factors do not provide any incremental pricing information to the corporate bond market factor. In addition, when considering duration-adjusted corporate bond returns, the market factors in the equity and bond CAPM display nontrivial pricing ability for several cross-sections of corporate bond returns. Finally, pricing industry sorted corporate bond portfolios appears to be quite demanding for all of the considered factor models. Our results challenge the status quo with respect to priced risk in the cross-section of corporate bond returns.

Trading volume and liquidity provision in cryptocurrency markets

joint with Daniele Bianchi (Queen Mary) and Mykola Babiak (Lancaster), Journal of Banking & Finance, Volume 142, May 2022

Abstract:

We provide empirical evidence within the context of cryptocurrency markets that the returns from liquidity provision, proxied by the returns of a short-term reversal strategy, are primarily concentrated in trading pairs with lower levels of market activity. Empirically, we focus on a moderately large cross section of cryptocurrency pairs traded against the U.S. Dollar from March 1, 2017 to March 1, 2022 on multiple centralised exchanges. Our findings suggest that expected returns from liquidity provision are amplified in smaller, more volatile, and less liquid cryptocurrency pairs where fear of adverse selection might be higher. A panel regression analysis confirms that the interaction between lagged returns and trading volume contains significant predictive information for the dynamics of cryptocurrency returns. This is consistent with theories that highlight the role of inventory risk and adverse selection for liquidity provision.

Working Papers

Pricing Corporate Bonds with Credit Risk Primitives

Abstract

This paper introduces a novel corporate bond risk factor exploiting the interaction between credit spreads and bond duration, generating a large risk-premium even after controlling for market risk and transaction costs. We propose a parsimonious three-factor model incorporating this factor alongside the Treasury and corporate bond market factors, outperforming more complex multi-factor models. The new factor is driven by default news and risk premium news. The factor falls when defaults unexpectedly rise and when the market risk premium falls, providing a unified explanation for the various corporate bond anomalies associated with tail and credit risk.

Data and Code

Coming soon.

The Low Frequency Trading Arms Race: Machines Versus Delays

(Winner of the Wellington Finance Summit Best Paper Award 2024)

Abstract

We propose a novel framework to compute transaction costs of trading strategies using infrequently traded assets.  The method explicitly accounts for the trade-off between bid-ask spreads and execution delays.  The benefit of waiting for a better trading opportunity with lower bid-ask spreads is partly offset by the opportunity cost of delayed or missed execution.  Applying this method to corporate bonds that trade infrequently, we show that even the latest machine-learning-based trading strategies earn zero or negative bond CAPM alphas after transaction costs. Consequently, our results raise doubts about the realistic outperformance capabilities of active bond trading strategies relative to the bond market factor.

Data and Code

Back-testing software, data and code coming soon.

The Corporate Bond Factor Zoo

joint with Christian Julliard (LSE and CEPR) and Philippe Mueller (Warwick Business School)

Abstract

Analyzing over 562 trillion possible models, we find that the majority of tradable factors designed to price bond markets are unlikely sources of priced risk, and only one novel factor, capturing the bond post-earnings announcement drift, should be included in the stochastic discount factor (SDF) with very high probability. Nevertheless, the SDF is dense in the space of observable factors, with both nontradable and equity-based factors being salient for pricing corporate bonds, and a Bayesian model averaging–SDF explains corporate risk premia better than all existing models, both in- and out-of-sample, and captures business cycle and market crash risks. 

Data and Code

See The Bond Factor Zoo.

Common Pitfalls in the Evaluation of Corporate Bond Strategies

joint with Cesare Robotti (Warwick Business School) and Giulio Rossetti (Warwick Business School)

Abstract

We argue that the documented large abnormal returns to investors from a wide array of corporate bond strategies mainly stem from ignoring market microstructure noise in transaction-based bond prices and relying on (ad hoc and asymmetric) out-of-sample return trimming or winsorization. To address these issues, we construct bond data that is largely free of microstructure noise and closely mimics industry-grade quote data. We revisit prior findings in the literature and provide conclusive evidence that most bond anomaly portfolios/factors, once properly constructed, generate negligible average returns and alphas. Finally, we show that the considered factors (and their underlying signals) are only weakly related to average bond returns.

Data and Code

See the Data downloads section on the companion website here.

A Credit Risk Explanation of the Correlation between Corporate Bonds and Stocks

joint with Mathieu Fournier (UNSW Business School), Alexandre Jeanneret (UNSW Business School) and Philippe Mueller (Warwick Business School)

Abstract

We develop a model to study the correlation between corporate bonds and stocks. Firms are exposed to a common asset factor with stochastic volatility, and interest rate fluctuations. The model predicts opposite variance and interest rate exposures of stocks and bonds, breaking the perfect comovement implied by mainstream theories. Quantitatively, asset and interest rate risks drive the tight link between stock-bond correlation and default risk. The model also suggests that the Sharpe ratio of portfolios combining stocks and bonds increases with firms' creditworthiness. We provide empirical support for the model predictions and show that they have important implications for asset allocation.