An Asset Pricing Approach to Liquidity Effects in Corporate Bond Markets
Erasmus University Rotterdam (EUR) - Finance
Frank De Jong
Tilburg University - Department of Finance
Tilburg University - Department of Finance; CentER Tilburg University
March 12, 2012
We use an asset pricing approach to compare the effects of expected liquidity and liquidity risk on expected U.S. corporate bond returns. Liquidity measures are constructed for bond portfolios using a Bayesian approach to estimate Roll’s measure. The results show that expected bond liquidity and exposure to equity market liquidity risk affect expected bond returns, and that these liquidity effects explain a substantial part of the credit spread puzzle. In contrast, we find robust evidence that exposure to corporate bond liquidity shocks carries an economically negligible risk premium. We develop a simple theoretical model that can explain this finding.
Number of Pages in PDF File: 65
Keywords: Liquidity premium, liquidity risk, corporate bonds, credit spread puzzle
JEL Classification: C51, G12, G13
Date posted: April 23, 2011 ; Last revised: March 14, 2012
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