Internal Liquidity Risk in Corporate Bond Yield Spreads: Bond- and Market-Level Evidences
64 Pages Posted: 18 Mar 2009 Last revised: 5 Sep 2010
Date Written: January 12, 2009
The recent global financial crisis reveals the important role of internal liquidity risk in corporate credit risk. However, hardly have any existing studies investigated its effects on bond yield spreads. This study employs both bond- and market-level data to address the issue. Bond-level results show that corporate internal liquidity volatility significantly impacts bond yield spreads when controlling for well-known variables, traditional accounting measures of corporate debt servicing ability and an additional structural form credit risk measure (the cash flow volatility). Further, this study finds that a systematic internal liquidity risk factor can materially capture market-wide bond yield spread changes. Market-level results also show that market-level internal liquidity risk significantly explains the spreads of bond indexes when controlling for factors of bond and equity markets and other major macro state variables. We conclude that internal liquidity risk should be incorporated into bond yield spread modeling.
Keywords: Flow-based credit risk, Internal liquidity risk, Bond yield spreads
JEL Classification: G10, G30
Suggested Citation: Suggested Citation