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Sh,
Looking at 5YR T-Notes over this same period, we find that the loading on the market factor is +0.10, and equity risk explains aproximately 7% of the returns. Clearly less than corporate bonds (even AAA), but not exactly worlds apart.
Yes Fama-French get the Beta of 1-5 Government bonds at 0.08, with ‘equity risk’ explaining 7% of the variation in excess returns (over the 1963-1991 time period). IMO illustrating a ‘not insignificant’ difference in ‘equity risk’ between Treasuries and AAA/AA bonds (more than seems to be often suggested). But I agree the gap between AAA/AA and junk bonds is larger.
In order to avoid any "equity risk", you had to look at 1YR T-Notes -- ie. short durations
Yes, because there is also term risk in stocks and bonds. But would argue that credit risk shows up more than term risk during times of financial crisis (e.g. Asian Crisis, current credit crunch…).
Thats one way to look at it, and for investors who look at their accounts daily (which seems like most) or even weekly, you probably should adopt a default free Treasury bond portfolio to dilute stocks.
My sense (from the threads on this forum) is that investors look at their portfolios more during extreme conditions. Not everyone's 'bullet-proof' (myself included).
However, its not a free lunch. AAA corporate bonds offer a credit risk premium (that shows up in times of severe liquidity crisis)...and this has annualized at about 0.60% annually (73-07)* (comparing LEH Treasury with LEH Credit Indexes). Treasury bonds have only outpaced Credit bonds in some downturns (73-74, 90, and 07-08, but not 81-82 or 00-02).
Yes, treasuries don’t always outperform, but they seem to help more during times of financial crisis.
assuming yields offer some indiciation of future maturity/credit premiums, high quality bonds now offer risk premiums of 3X as much as the historical average
Expected future equity returns are also now likely higher than they were at the beginning of the year (some of which is likely reflected in the higher expected corporate bond returns – following the FF research). And if an investor has a lower fixed income allocation (due to use of treasuries vs. corporate bonds for fixed income), then the expected portfolio returns are likely higher.
My current interest in credit risk is that we have an environment where we can assess the ex-ante expected performance of bonds of varying quality. The relative performance seems as expected (not based only on back-tested returns, but also on their fundamental characteristics). Interesting to see…
Robert
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