Abstract

http://ssrn.com/abstract=1420294
 
 

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Illiquidity or Credit Deterioration: A Study of Liquidity in the US Corporate Bond Market during Financial Crises


Nils Friewald


Vienna University of Economics and Business

Rainer Jankowitsch


WU (Vienna University of Economics and Business)

Marti G. Subrahmanyam


New York University - Stern School of Business

March 12, 2010


Abstract:     
We use a unique data-set to study liquidity effects in the US corporate bond market, covering more than 20,000 bonds. Our analysis explores time-series and cross-sectional aspects of corporate bond yield spreads, with the main focus being on the quantification of the impact of liquidity factors, while controlling for credit risk. Our time period starts in October 2004 when detailed transaction data from the Trade Reporting and Compliance Engine (TRACE) became available. In particular, we examine three different regimes during our sample period, the GM/Ford crisis in 2005 when a segment of the corporate bond market was affected, the sub-prime crisis since mid-2007, which was much more pervasive across the corporate bond market, and the period in between, when market conditions were more normal.

We employ a wide range of liquidity measures and find in our panel-regression analysis that liquidity effects account for approximately one-tenth of the explained market-wide corporate yield spread changes. During periods of crisis, the economic impact of the liquidity measures increases significantly. Our data-set allows us to examine in greater detail liquidity effects in various sub-segments of the market: investment grade vs. speculative grade bonds, financial sector firms which have been particularly affected by the crisis vs. industrial firms, and retail vs. institutional trades. In addition, our cross-sectional analysis based on Fama-MacBeth regressions shows that liquidity explains an important part of the variation in yield spreads across bonds, after accounting for credit risk. These results yield important insights regarding the liquidity drivers of corporate bond yield spreads, particularly during periods of crisis.

Number of Pages in PDF File: 40

Keywords: Liquidity, Corporate Bonds, Financial Crises, OTC Markets

JEL Classification: G01, G12, G14

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Date posted: June 16, 2009 ; Last revised: March 17, 2010

Suggested Citation

Friewald, Nils and Jankowitsch, Rainer and Subrahmanyam, Marti G., Illiquidity or Credit Deterioration: A Study of Liquidity in the US Corporate Bond Market during Financial Crises (March 12, 2010). Available at SSRN: http://ssrn.com/abstract=1420294 or http://dx.doi.org/10.2139/ssrn.1420294

Contact Information

Nils Friewald
Vienna University of Economics and Business ( email )
Heiligenstaedter Strasse 46-48
Vienna, 1190
Austria
+43 1 31336 6303 (Phone)
+43 1 31336 906303 (Fax)
Rainer Jankowitsch (Contact Author)
WU (Vienna University of Economics and Business) ( email )
Welthandelsplatz 1
Vienna, Vienna AT1020
Austria
+43 1 31 336 4340 (Phone)
+43 1 310 0580 (Fax)
Marti G. Subrahmanyam
New York University - Stern School of Business ( email )
Stern School of Business,
44 West 4th Street, Suite 9-68
New York, NY 10012-1126
United States
212-998-0348 (Phone)
212-995-4233 (Fax)
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References:  32
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