Liquidity, Returns and Investor Heterogeneity in the Corporate Bond Markets
38 Pages Posted: 17 Mar 2008 Last revised: 2 Jul 2020
Date Written: March 14, 2008
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: Suggested Citation