Dealer inventory and the cross-section of corporate bond returns

We empirically study the role of dealers’ inventory risk in US corporate bond returns. To do so, we build a bond-level measure of exposure to inventory risk and find that the risk-adjusted return of a high-minus-low portfolio is 21 basis points per week. The inventory risk premium is amplified during times of crises, if hedging supply is low, as well as for bonds with higher credit risk. Our findings provide strong support for the asset pricing implication of inventory models and show that dealers use price pressure to compensate for bearing inventory risk.