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Returns and Volatility of Low-Grade Bonds 1977–1989

Authors

  • MARSHALL E. BLUME,

  • DONALD B. KEIM,

  • SANDEEP A. PATEL

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    • Blume and Keim are from the Wharton School, University of Pennsylvania, and Patel is from Texas Christian University. This paper was previously titled “The Components of Lower-Grade Bond Price Variability.” We thank Stephen Foerster, George Pennacchi, René Stulz (editor), Mark Weinstein, an anonymous referee and participants in presentations at the Berkeley Program in Finance, the Garn Institute Symposium, Harvard, the NYU Conference on the High Yield Debt Market, the University of Western Ontario, and Wharton for helpful comments. Neelu Agrawal, Suzanne Barrett, and Todd Rosentover provided excellent research assistance. Remaining errors are ours.

ABSTRACT

This paper examines the risks and returns of long-term low-grade bonds for the period 1977–1989. We find: (1) low-grade bonds realized higher returns than higher-grade bonds and lower returns than common stocks, and low-grade bonds exhibited less volatility than higher-grade bonds due to their call features and high coupons; (2) there is no relation between the age of low-grade bonds and their realized returns; cyclical factors explain much of the observed relation between default rates and bond age; and (3) low-grade bonds behave like both bonds and stocks. Despite this complexity there is no evidence that low-grade bonds are systematically over- or under-priced.

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