Corporate bond returns exhibit predictability in a manner consistent with efficient pricing. Many equity characteristics, such as accruals, standardized unexpected earnings, and idiosyncratic volatility, do not impact bond returns. Profitability and asset growth are negatively related to corporate bond returns. Because firms that are profitable or have high asset growth (and hence more collateral) should be less risky, with lower required returns, the evidence accords with the risk–reward paradigm. Past equity returns are positively related to bond returns, indicating that equities lead bonds. Cross-sectional bond return predictors generally do not provide materially high Sharpe ratios after accounting for trading costs.

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I decompose the cross-sectional variation of the credit spreads for corporate bonds into changing expected returns and changing expectation of credit losses with a modelfree method. Using a log-linearized pricing identity and a vector autoregression applied to micro-level data from 1973 to 2011, I …nd that the expected credit loss component and the excess return component each explains about half of the variance of the credit spreads. Unlike the market-level …ndings in Gilchrist and Zakrajšek (2012), at the …rm level, the expected credit loss is volatile and a¤ects the …rms'investment decision more than the expected excess returns.

This paper examines dealer inventory capacity, or liquidity supply, as a driver of liquidity and expected returns in the corporate bond market. We identify shocks to aggregate liquidity supply using data on corporate bond yields and dealer positions. Liquidity supply shocks lead to persistent changes in market liquidity, are correlated with proxies for dealer financial constraints, and have significant explanatory power for cross‐sectional and time‐series variation in expected returns, beyond standard risk factors. Our findings point to liquidity supply by financially constrained intermediaries as a main driver of market liquidity and asset prices.