Liquidity Effects in Corporate Bond Spreads

43 Pages Posted: 23 Nov 2011 Last revised: 18 Aug 2013

See all articles by Jean Helwege

Jean Helwege

UC Riverside

Jing-Zhi Huang

Pennsylvania State University - University Park - Department of Finance

Yuan Wang

Concordia University, Quebec

Date Written: August 17, 2013

Abstract

Corporate bond spreads are affected by both credit risk and liquidity and it is difficult to disentangle the two factors empirically. In this paper we separate out the credit risk component by examining bonds that are issued by the same firm and that trade on the same day. Our sample of bond pairs provides two yield spreads which, if they differ, vary only because of differences in liquidity. We then investigate the determinants of the differences in yield spreads. We find that standard liquidity measures do a poor job of explaining spreads, and that incorporating the information from other bonds issued by the firm and from bonds of other firms can significantly improve the explanatory power of those liquidity measures. Still, a significant portion of the spread is left unexplained and it is largely driven by a common unknown factor. We conclude that good proxies for the liquidity component of corporate bond spreads remain elusive.

Keywords: Corporate bond spreads, Liquidity risk, Credit risk, Pairwise difference estimation

Suggested Citation

Helwege, Jean and Huang, Jing-Zhi Jay and Wang, Yuan, Liquidity Effects in Corporate Bond Spreads (August 17, 2013). Journal of Banking and Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1364681 or http://dx.doi.org/10.2139/ssrn.1364681

Jean Helwege (Contact Author)

UC Riverside ( email )

900 University Ave.
Anderson Hall
Riverside, CA 92521
United States
9518274284 (Phone)

Jing-Zhi Jay Huang

Pennsylvania State University - University Park - Department of Finance ( email )

University Park, PA 16802
United States

HOME PAGE: http://www.personal.psu.edu/jxh56

Yuan Wang

Concordia University, Quebec ( email )

1455 de Maisonneuve Blvd. W.
Montreal, Quebec H3G 1MB
Canada

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