On the determinants of expected corporate bond returns in Tunisia

• Characteristics are proxies of total risk, while betas are proxies of systematic risks.
• Ratings in the Tunisian bond market are the most important determinant of expected corporate bond returns.
• When we account for characteristics, we find that systematic risks do not explain the cross-section of expected bond returns.
• Investors’ pessimism or the inability to hold diversifiable portfolios are likely to explain why characteristics explain Tunisian bond returns.
• The practical implication of the empirical results is that Tunisian bonds offer huge opportunities for sophisticated investors.

In this paper, we document that ratings in the Tunisian bond market are the most important determinant of expected corporate bond returns. When we account for this characteristic, we find that systematic risks do not explain the cross-section of expected bond returns. These findings are obtained for a wide range of systematic factors, so the omitted variables problem cannot justify the failure of asset pricing models to explain expected corporate bond returns in Tunisia. Mispricing due to pessimistic investors or their inability to hold diversifiable bond portfolios are likely to explain why characteristics fare better than betas in explaining bond returns in Tunisia.