Corporate Bond Portfolios and Macroeconomic Conditions∗

We propose an approach to optimally select corporate bond portfolios based on bond-specific characteristics (maturity, credit rating, coupon, illiquidity, past performance, and issue size) and macroeconomic conditions (recessions and macroeconomic uncertainty measures). The approach relies on a parametric specification of the portfolio weights and allows us to consider a large cross-section of corporate bonds. During economic expansions, the optimal corporate bond portfolio is tilted toward bonds with longer maturity and worse credit rating (high ex-ante default risk), relative to the benchmark. By contrast, in periods of macroeconomic downturns and high uncertainty, the optimal strategy exhibits a flight-to-safety aspect and favors short maturity and relatively better rated bonds. In all regimes, corporate bonds with high coupons, high past performance, and small size of issuance lead to higher certainty equivalent returns. Overall, we find that the characteristics used in the corporate bond pricing literature to proxy for various sources of risk are also useful in forming corporate bond portfolios. Conditioning on these characteristics and macroeconomic variables leads to a significant improvement in portfolio performance, with the certainty equivalent increasing about 5% per annum after conservative transaction costs. The gain in performance is evenly divided between expansions and contractions and is not exclusively concentrated in high-yield bonds. We observe similar gains in portfolio performance out of sample. JEL-Classification: G11, G12, C58, C13