Liquidity Risk Premia in Corporate Bond Markets
Frank De Jong
Tilburg University - Department of Finance
Tilburg University - Department of Finance; CentER Tilburg University
September 22, 2006
This paper explores the role of liquidity risk in the pricing of corporate bonds. We show that corporate bond returns have signifcant exposures to fluctuations in treasury bond liquidity and equity market liquidity. Further, this liquidity risk is a priced factor for the expected returns on corporate bonds, and the associated liquidity risk premia help to explain the credit spread puzzle. In terms of expected returns, the total estimated liquidity risk premium is around 0.6% per annum for US long-maturity investment grade bonds. For speculative grade bonds, which have higher exposures to the liquidity factors, the liquidity risk premium is around 1.5% per annum. We find very similar evidence for the liquidity risk exposure of corporate bonds for a sample of European corporate bond prices.
Number of Pages in PDF File: 47
Keywords: Credit spread, liquidity premium
JEL Classification: G12, G13
Date posted: April 8, 2005 ; Last revised: May 7, 2009
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