Risk factors in Australian bond returns

This study examines the risk factors in Australian bond returns. The study quantifies bond liquidity and estimates a liquidity risk factor in the Australian setting. We develop a three-factor asset pricing framework that uses term, default and liquidity risk factors to explain the variation of Australian bond returns. Our findings corroborate the US evidence on the pervasiveness of these risk factors faced by bond investors. The three-factor model developed in this study has practical applications when calculating the cost of debt, evaluating the performance of an active bond fund manager and hedging underlying risk in a bond portfolio.