Download this Paper Open PDF in Browser

Illiquidity or Credit Deterioration: A Study of Liquidity in the US Corporate Bond Market during Financial Crises

40 Pages Posted: 16 Jun 2009 Last revised: 17 Mar 2010

Nils Friewald

Norwegian School of Economics (NHH)

Rainer Jankowitsch

WU (Vienna University of Economics and Business)

Marti G. Subrahmanyam

New York University - Stern School of Business

Multiple version iconThere are 3 versions of this paper

Date Written: March 12, 2010

Abstract

We use a unique data-set to study liquidity effects in the US corporate bond market, covering more than 20,000 bonds. Our analysis explores time-series and cross-sectional aspects of corporate bond yield spreads, with the main focus being on the quantification of the impact of liquidity factors, while controlling for credit risk. Our time period starts in October 2004 when detailed transaction data from the Trade Reporting and Compliance Engine (TRACE) became available. In particular, we examine three different regimes during our sample period, the GM/Ford crisis in 2005 when a segment of the corporate bond market was affected, the sub-prime crisis since mid-2007, which was much more pervasive across the corporate bond market, and the period in between, when market conditions were more normal.

We employ a wide range of liquidity measures and find in our panel-regression analysis that liquidity effects account for approximately one-tenth of the explained market-wide corporate yield spread changes. During periods of crisis, the economic impact of the liquidity measures increases significantly. Our data-set allows us to examine in greater detail liquidity effects in various sub-segments of the market: investment grade vs. speculative grade bonds, financial sector firms which have been particularly affected by the crisis vs. industrial firms, and retail vs. institutional trades. In addition, our cross-sectional analysis based on Fama-MacBeth regressions shows that liquidity explains an important part of the variation in yield spreads across bonds, after accounting for credit risk. These results yield important insights regarding the liquidity drivers of corporate bond yield spreads, particularly during periods of crisis.

Keywords: Liquidity, Corporate Bonds, Financial Crises, OTC Markets

JEL Classification: G01, G12, G14

Suggested Citation

Friewald, Nils and Jankowitsch, Rainer and Subrahmanyam, Marti G., Illiquidity or Credit Deterioration: A Study of Liquidity in the US Corporate Bond Market during Financial Crises (March 12, 2010). Available at SSRN: https://ssrn.com/abstract=1420294 or http://dx.doi.org/10.2139/ssrn.1420294

Nils Friewald

Norwegian School of Economics (NHH) ( email )

Helleveien 30
Bergen, NO-5045
Norway

Rainer Jankowitsch (Contact Author)

WU (Vienna University of Economics and Business) ( email )

Welthandelsplatz 1
Vienna, Vienna AT1020
Austria
+43 1 31 336 4340 (Phone)
+43 1 310 0580 (Fax)

Marti G. Subrahmanyam

New York University - Stern School of Business ( email )

Stern School of Business,
44 West 4th Street, Suite 9-68
New York, NY 10012-1126
United States
212-998-0348 (Phone)
212-995-4233 (Fax)

Paper statistics

Downloads
692
Rank
16,914
Abstract Views
2,997