Idiosyncratic Volatility vs. Liquidity? Evidence from the U.S. Corporate Bond Market

53 Pages Posted: 23 Mar 2009 Last revised: 26 Jul 2011

See all articles by Madhu Kalimipalli

Madhu Kalimipalli

Lazaridis School of Business and Economics, Wilfrid Laurier University

Subhankar Nayak

Wilfrid Laurier University - Financial Services Research Centre

Multiple version iconThere are 2 versions of this paper

Date Written: May 31, 2010

Abstract

Our main objective in this paper is to determine empirically the extent to which fixed-income investors are concerned about equity volatility and bond liquidity in corporate bond spreads. We extend Campbell and Taksler (2003) by conditioning for underlying bond liquidity, and exploring the relative contribution of idiosyncratic equity volatility and bond liquidity in the cross-sectional pricing of corporate bond spreads. Portfolio analysis and Fama-Macbeth regressions reveal that while both volatility and liquidity effects are significant, volatility (representing ex-ante credit shock) has the first-order impact, and liquidity (represented by bond characteristics and price impact measure) has the secondary impact on bond spreads. Conditional analysis further reveals that distressed bonds and distress regimes are both associated with significantly higher impact of credit and liquidity shocks. However, the relative impact of these shocks varies. Volatility effects are more prominent for distressed bonds and during high-distress regimes; liquidity effects are stronger for less distressed bonds and during low-distress regimes. Our findings also indicate that, unlike equity markets, idiosyncratic risk does not subsume the information in liquidity in explaining corporate bond spreads.

Keywords: bond liquidity, equity volatility, illiquid markets, corporate bond spreads, Fama-Macbeth regressions

JEL Classification: G10, G14

Suggested Citation

Kalimipalli, Madhu and Nayak, Subhankar, Idiosyncratic Volatility vs. Liquidity? Evidence from the U.S. Corporate Bond Market (May 31, 2010). Available at SSRN: https://ssrn.com/abstract=1364303 or http://dx.doi.org/10.2139/ssrn.1364303

Madhu Kalimipalli (Contact Author)

Lazaridis School of Business and Economics, Wilfrid Laurier University ( email )

Waterloo, Ontario N2L 3C5
Canada
519-884-0710 (Phone)

HOME PAGE: http://www.madhukalimipalli.com/

Subhankar Nayak

Wilfrid Laurier University - Financial Services Research Centre ( email )

Waterloo, Ontario N2L 3C5
Canada

Register to save articles to
your library

Register

Paper statistics

Downloads
259
Abstract Views
1,447
rank
117,201
PlumX Metrics