Time-varying risk and return characteristics of US and European bond markets: Implications for efficient portfolio allocation Received (in revised form): 25th July, 2007 Philip J. Young n is Professor of Finance and holds the Tom E. Hendrix Chair of Excellence in Free Enterprise at the University of Tennessee at Martin. He earned a PhD in Finance from the University of Arkansas and holds a BS in Agriculture from the University of Missouri as well as an MBA from the University of Central Missouri. He earned the Chartered Financial Analyst s designation in 1997. He served as Vice President-Curriculum and Examinations at CFA Institute from 2000 to 2005. Prior to joining CFA Institute, he was employed at Southwest Missouri State University, where he earned the rank of Associate Professor. He has published in a number of financial journals including the Journal of Financial Economics and The Financial Review. Thomas H. Payne is Professor of Finance and holds the Horace and Sara Dunagan Chair of Excellence in Banking at the University of Tennessee at Martin. He earned a PhD in Finance from the University of Arkansas and holds an MBA from the University of Texas at Dallas as well as a BS in Electrical Engineering from the University of Arkansas. Prior to his career in academia, he worked for Texas Instruments and Rockwell International. He serves on the faculty of the Barret School of Banking in Memphis and as a visiting professor in the University of Orleans (France) Masters of European Management Program. He has over 30 publications in academic and practitioner journals and was the 2006–2007 President of the Southwestern Finance Association. Robert R. Johnson is the Managing Director of the Education Division at CFA Institute, Charlottesville, Virginia, USA. He received his BSBA from the University of Nebraska-Omaha, his MBA from Creighton University, and his PhD from the University of Nebraska-Lincoln. He earned the Chartered Financial Analyst s (CFA s ) designation in 1991. He joined CFA Institute in 1996 and, among other duties, is responsible for overseeing the CFA Program. Prior to joining CFA Institute, he earned the rank of Professor at Creighton University. He has published over 50 articles in financial publications and is a member of the advisory board of both the Journal of Portfolio Management and the Journal of Wealth Management. n Correspondence: 109 Business Administration Building, Martin, TN 38238, USA. Tel: +1 731 881 7228; Fax: +1 731 881 7256; E-mail: pyoung@utm.edu Abstract This study examines return volatility among the Swiss, German, UK, and US bond markets by comparing both in-country and US-based returns and risk measures. Our findings include: (1) volatility of in-country bond market returns has been much higher in the US and UK than in Switzerland or Germany; (2) although adding to return volatility, currency returns have generally enhanced overall returns to US-based investors in European bonds; (3) low correlations between US bond market returns and European bond market returns offer potential diversification benefits; (4) overall, the risk per unit of return has been much greater in the US bond market and much lower in the German market than in the Swiss or UK markets; and (5) the risk per unit of return has been much more stable for the Swiss and German bond markets than for the UK or US markets. Our results show that global bond market investors can achieve the greatest efficiency in terms of risk per unit of return by hedging currency risk. The relatively low correlations of returns among these markets afford a global investor the opportunity to improve risk-return efficiency by diversifying among the three markets. This study offers important insights for US-based investors seeking the optimal bond portfolio allocation in risk-return space. Journal of Asset Management (2007) 8, 337–350. doi:10.1057/palgrave.jam.2250086 Keywords: global bond markets, bond market volatility, bond market risk and return & 2007 Palgrave Macmillan Ltd, 1470-8272 $30.00 Vol. 8, 5, 337–350 Journal of Asset Management 337 www.palgrave-journals.com/jam