Liquidity, Returns and Investor Heterogeneity in the Corporate Bond Markets

38 Pages Posted: 17 Mar 2008 Last revised: 2 Jul 2020

See all articles by Robert Guo

Robert Guo

Federal Reserve Banks - Federal Reserve Bank of New York

Asani Sarkar

Federal Reserve Bank of New York

Til Schuermann

Oliver Wyman

Date Written: March 14, 2008

Abstract

We examine how investor heterogeneity affects the relation between liquidity changes and yield spread changes, using newly-available trade data for more than 3,700 bonds of 635 issuers. We find that, for retail trades, liquidity is a significant determinant of yield spreads and adds substantially to the explanatory power of regressions, after accounting for issuer and market risk. Further, the impact of liquidity is inversely related to retail traders' expected holding period. In contrast, for institutional trades, liquidity and yield spreads are essentially unrelated at all holding periods. We further find, for retail traders, the return premia to holding illiquid bond portfolios is positive and concave in the expected holding period, as predicted by Amihud and Mendelson (1986). Moreover, retail traders earn greater return premia than institutions for the same holding period. Thus, the market at least partially compensates retail investors for the greater illiquidity of their bond trades. Our results point to the importance of investor heterogeneity for understanding the determinants of credit risk.

Keywords: corporate bonds, liquidity, retail traders, institutions

JEL Classification: G00, G12, G14

Suggested Citation

Guo, Robert and Sarkar, Asani and Schuermann, Til, Liquidity, Returns and Investor Heterogeneity in the Corporate Bond Markets (March 14, 2008). Available at SSRN: https://ssrn.com/abstract=1106415 or http://dx.doi.org/10.2139/ssrn.1106415

Robert Guo

Federal Reserve Banks - Federal Reserve Bank of New York

33 Liberty Street
New York, NY 10045
United States

Asani Sarkar (Contact Author)

Federal Reserve Bank of New York ( email )

Research Department
33 Liberty Street
New York, NY 10045
United States
212-720-8943 (Phone)
212-720-1582 (Fax)

HOME PAGE: http://www.newyorkfed.org/research/economists/sarkar/pub.html

Til Schuermann

Oliver Wyman ( email )

1166 6th Avenue
New York City, NY
United States

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