The Same Bond at Different Prices: Identifying Search Frictions and Selling Pressures
68 Pages Posted: 3 Jun 2009 Last revised: 16 Mar 2010
Date Written: March 5, 2010
I model how corporate bond prices are affected by search frictions and occasional selling pressures and test my predictions empirically. A key prediction is that in a distressed market with more sellers than buyers, prices paid by large traders decrease more than those of small traders. Using a structural estimation, the model is able to identify liquidity crises (i.e. high number of forced sellers) based on the relative prices of small and large traders. New light is shed on two crises, the downgrade of GM and Ford in 2005 and the subprime crisis. The model can also explain why the spread between corporate bond yields and Treasury yields is so large, the so-called credit spread puzzle.
Keywords: liquidity, corporate bonds, search frictions, selling pressure, over-the-counter
JEL Classification: G12
Suggested Citation: Suggested Citation