Constructing Daily Equity Momentum Portfolios Using Corporate Bond Data

Abstract

Do corporate bond return dynamics contain information that is not already fully reflected in equity prices despite the lower liquidity of credit markets? Using a comprehensive dataset of US corporate bond pricing and analytics, the authors show that daily bond returns can be used to construct a high-frequency equity momentum strategy. A long–short portfolio formed by ranking stocks on past daily excess returns of bonds issued by the same firms generated annual returns of 18% on average since 2001 with an information ratio of over 1.8. The performance was consistent over time and across economic states and different geographies and remained significant after controlling for commonly used equity factors. Momentum and mean-reversion strategies applied to the same universe of companies but instead using daily equity data did not generate similar results.

TOPICS: Portfolio theory, portfolio construction, equity portfolio management

Key Findings

• • Daily corporate bond pricing data can be used in constructing a high-frequency equity momentum strategy.

• • A daily trading strategy that buys stocks whose bonds outperformed relative to peers and shorts stocks whose bonds underperformed relative to peers generates an improved risk–return profile compared with a similar trend strategy based on daily equity price dynamics.

• • The strategy is attractive both in isolation and in combination with other strategies, delivering significant risk-adjusted alpha.