Liquidity and Credit Risk
McGill University; Swedish Institute for Financial Research (SIFR)
University of Warwick Business School - Financial Econometrics Research Centre
May 9, 2002
EFA 2003 Glasgow
We develop a structural bond valuation model to simultaneously capture liquidity and credit risk. Our model implies that renegotiation in financial distress is influenced by the illiquidity of the market for distressed debt. As default becomes more likely, the components of bond yield spreads attributable to illiquidity increase. When we consider finite maturity debt, we find decreasing and convex term structures of liquidity spreads. Using bond price data spanning 15 years, we find evidence of a positive correlation between the illiquidity and default components of yield spreads as well as support for downward sloping term structures of liquidity spreads.
Number of Pages in PDF File: 48
Keywords: Credit risk, corporate bonds, renegotiation, illiquidity
JEL Classification: G12, G13working papers series
Date posted: August 1, 2003
© 2013 Social Science Electronic Publishing, Inc. All Rights Reserved.
This page was processed by apollo7 in 0.547 seconds