Bond Illiquidity and Excess Volatility

52 Pages Posted: 13 Mar 2008 Last revised: 19 May 2013

See all articles by Jack Bao

Jack Bao

University of Delaware - Department of Finance

Jun Pan

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF); National Bureau of Economic Research (NBER); China Academy of Financial Research (CAFR)

Date Written: May 9, 2013

Abstract

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

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

Jack Bao

University of Delaware - Department of Finance ( email )

Alfred Lerner College of Business and Economics
Newark, DE 19716
United States

Jun Pan (Contact Author)

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF) ( email )

Shanghai Jiao Tong University
211 West Huaihai Road
Shanghai, 200030
China

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

China Academy of Financial Research (CAFR)

1954 Huashan Road
Shanghai P.R.China, 200030
China

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