with B. Kelly and D. Palhares
Forthcoming, Journal of Finance
We propose a conditional factor model for corporate bond returns with five factors and time-varying factor loadings. We have three main empirical findings. First, our factor model excels in describing the risks and returns of corporate bonds, improving over previously proposed models in the literature by a large margin. Second, our benchmark model recommends a systematic bond investment portfolio that significantly outperforms leading corporate credit investment strategies. Third, we find closer integration between debt and equity markets than found in prior literature.