The strategy targets USD-denominated corporate bonds, using a book-to-market signal to identify underpriced and overpriced bonds. It involves a quintile-based, value-weighted, monthly rebalanced spread approach.
ASSET CLASS: bonds | REGION: United States | FREQUENCY:
Monthly | MARKET: bonds | KEYWORD: Corporate Bond, Value
I. STRATEGY IN A NUTSHELL
This strategy trades senior unsecured USD-denominated corporate bonds from non-financial firms, excluding those with options other than calls. Bonds are ranked monthly by a book-to-market signal (book value per unit of face amount ÷ market price). A value-weighted spread strategy goes long on the top quintile (underpriced) and short on the bottom quintile (overpriced). Trades are rebalanced monthly, with the approach best suited for bonds already scheduled for trading due to high transaction costs.
II. ECONOMIC RATIONALE
The book-to-market signal identifies mispricing in corporate bonds, capturing underpriced and overpriced instruments. By taking long positions in bonds with high book-to-market ratios and short positions in low ratios, the strategy exploits persistent valuation gaps. High transaction costs make it most effective when applied alongside pre-planned bond trades, allowing investors to capture excess returns efficiently.
III. SOURCE PAPER
Book-to-Market, Mispricing, and the Cross-Section of Corporate Bond Returns [Click to Open PDF]
Söhnke M. Bartram, University of Warwick; Mark Grinblatt, Centre for Economic Policy Research (CEPR); Yoshio Nozawa, University of California, Los Angeles (UCLA) – Finance Area, Yale University – International Center for Finance, National Bureau of Economic Research (NBER); University of Toronto
<Abstract>
We study the role played by “bond book-to-market” ratios in U.S. corporate bond pricing. Controlling for numerous risk factors tied to default and priced asset risk, including yield-to-maturity, we find that the ratio of a corporate bond’s book value to its market price strongly predicts the bond’s future return. The quintile of bonds with the highest bond book-to-market ratios outperforms the quintile with the lowest ratios by more than 3% per year, other things equal. Additional evidence on signal delay, scope of signal efficacy, and factor risk rejects the thesis that the corporate bond market is perfectly informationally efficient.
IV. BACKTEST PERFORMANCE
| Annualised Return | 4.94% |
| Volatility | 5.81% |
| Beta | N/A |
| Sharpe Ratio | 0.85 |
| Sortino Ratio | N/A |
| Maximum Drawdown | N/A |
| Win Rate | N/A |
