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Returns and Volatility of Low-Grade Bonds 1977-1988

Marshall E. Blume, Donald Keim () and Sandeep A. Patel

Rodney L. White Center for Financial Research Working Papers from Wharton School Rodney L. White Center for Financial Research

Abstract: This paper examines the return characteristics of low-grade bonds using dealer bid prices. The volatility of an index of these bonds is less than the volatility of indexes of higher-grade bonds such as long-term Treasury bonds. This reduced volatility is due in large part to the shorter duration of low-grade bonds. We also present evidence that low-grade bonds are a hybrid security with features of both stocks and bonds. A detailed analysis of the returns realized by all low-grade bonds issued in 1977 and 1978 indicates that any relation between bond age and probability of default does not induce a bias in the results based on our index of lower-grade bonds. Moreover, we present evidence that at least part of the observed tendency for the probability of default to increase with age is due to cyclical factors.

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