52 Pages Posted: 13 Mar 2008 Last revised: 19 May 2013
Date Written: May 9, 2013
We find that the empirical volatilities of corporate bond and CDS returns are higher than implied by equity return volatilities and the Merton model. This excess volatility may arise because structural models inadequately capture either fundamentals or illiquidity. Our evidence supports the latter explanation. We find little relation between excess volatility and measures of firm fundamentals and the volatility of firm fundamentals, but some relation with variables proxying for time-varying illiquidity. Consistent with an illiquidity explanation, firm-level bond portfolio returns, which average out bond-specific effects, significantly decrease excess volatility.
Suggested Citation: Suggested Citation
Bao, Jack and Pan, Jun, Bond Illiquidity and Excess Volatility (May 9, 2013). AFA 2009 San Francisco Meetings Paper; Charles A. Dice Center Working Paper No. 2010-20; Fisher College of Business Working Paper No. 2010-03-020. Available at SSRN: https://ssrn.com/abstract=1104765 or http://dx.doi.org/10.2139/ssrn.1104765