Issuer Quality And Corporate Bond Returns
Changes in the pricing of credit risk disproportionately affect the debt financing costs faced by low credit quality firms. As a result, time-series variation in the average quality of debt issuers may be useful for forecasting excess corporate bond returns. The results can be partially explained by models in which shocks to intermediary capital or agency problems drive variation in required returns. Finally, they consider models in which investor over-extrapolation plays a role and find some evidence in favor of these models.