Predicting Bonds with Stock Characteristics

Predicting Bonds with Stock Characteristics

October 28, 2014 Research Insights
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(Last Updated On: January 18, 2017)

Is the Cross-Section of Expected Bond Returns Influenced by Equity Return Predictors?

  • Chordia, Goyal, Nozawa, Subrahmanyam and Tong
  • A version of the paper can be found here.
  • Want a summary of academic papers with alpha? Check out our Academic Research Recap Category.


Using a comprehensive cross-section and time-series of corporate bond returns assembled from multiple data sources, we analyze whether commonly analyzed equity return predictors also predict bond returns. There is a surprisingly strong monthly lead from equity to bond returns, indicating that new information gets reflected in the equity market first…Finally, consistent with a relatively sophisticated institutional clientele, bonds are efficiently priced in that none of the behaviorally-motivated variables predict returns after accounting for transactions costs, though some risk-based variables continue to do so.

Alpha Highlight:

In this paper, the authors test whether cross-sectional equity return predictors also predict bond returns. To be specific, paper sorts corporate bonds into 10 decile portfolios based on equity characteristics like Size (log MC), Value (log B/M), Momentum, Past month’s equity return, Accruals, Asset Growth, Idiosyncratic Volatility, and so on.

Chart below provides the expected signs of these variables under two categories of arguments, behavioral and risk-return.

2014-09-09 13_04_29-Is the cross-section of expected bond returns influenced by equity return predic

The next step in the research process is to check the predictive power of these variables from 1973 to 2011. The detailed sorting and holding methods can be found in the descriptions of the graph below. The paper finds that some predictors, such as size, value, profitability, and past returns, are strong predictors of bond returns (red arrows moving in a direction ==> predictability; red arrows moving flat ==> no predictive ability). Other variables, like accounting accruals and earnings surprises, are not very predictive. The economic significance of predictable varaibles is higher for junk bonds that it is for investment grade (IG) bonds.

csb5.pdf - Adobe Acrobat Pro_2014-09-24_16-52-53
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

The paper also investigates whether or not there are arbitrage opportunities in bond markets. After transaction costs are considered, the bond market is extremely efficient.

This no-free-lunch evidence jibes with my anecdotal evidence: The smartest people I know are bond traders and not equity traders.


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Definitions of common statistics used in our analysis are available here (towards the bottom)

About the Author

Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray earned a PhD, and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management that delivers affordable active exposures for tax-sensitive investors. Dr. Gray has published four books and a number of academic articles. Wes is a regular contributor to multiple industry outlets, to include the following: Wall Street Journal, Forbes,, and the CFA Institute. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.

  • Sebastian Jory

    Wesley – your conclusion doesn’t fit the results ? Maybe I am missing something. But if credit markets were totally efficient, then they should price any information reflected in equity markets instantaneously?

  • Hi Sebastian,
    This is the conclusion of the paper. You are technically correct in the sense that the efficient market hypothesis suggests that prices reflect all available information at all times. The term “efficiency” is used loosely here and relates to the idea that there are no arbitrage opportunities because of transaction costs.
    Good observation!

  • Sebastian Jory

    Ah sorry – so the charts are ex-transaction costs?
    I was missing something…