Diversifying Credit Risk With International Corporate Bonds
Source: University of Pennsylvania
This paper explores the potential for US investors to diversify credit risk exposure with international corporate bonds. Using a newly compiled dataset of firm-level monthly corporate bond quotes for foreign and domestic issues, the author shows that by adding foreign corporate bonds to a benchmark of US equity and bond portfolios, the investor achieves an economically significant reduction in portfolio risk particularly during periods of high volatility in the US markets such as the recent credit crisis. Further, in contrast to the observed US holdings in foreign bonds of 6%, the model implied portfolio holding in foreign corporate bonds should be 25% or more, which implies a potential bond home bias puzzle.