Returns and Volatility of Low-Grade Bonds 1977-1988

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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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