Volatility and Corporate Bond Pricing in China*

Abstract This paper investigates the impact of volatility on expected corporate bond returns in China by using transactional data from 2010 to 2022. Portfolio analysis and Fama‐MacBeth regression show that volatility has a negative impact on expected corporate bond returns. After controlling for credit rating, maturity, liquidity, stock volatility and risk exposures, the volatility effect remains significant. By incorporating a new volatility factor and the bond market factor into the term‐default two‐factor bond pricing model of Fama and French ( Journal of Financial Economics , 1993, 33, 3), we construct a new four‐factor pricing model of corporate bonds. The proposed model captures the premium of volatility risk well and makes a significant marginal contribution to explaining the excess returns of corporate bonds. In addition, we find that volatility has a predictive effect on the default of corporate bonds.