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Realized Volatility, Liquidity, and Corporate Yield Spreads

51 Pages Posted: 17 Mar 2010 Last revised: 3 Jan 2014

Marco Rossi

Texas A&M

Date Written: January 3, 2014

Abstract

I propose a friction measure of bond round-trip liquidity costs that is robust to outliers and accounts for the idiosyncratic information behind trading decisions. Particularly effective with investment-grade bonds, the proposed measure displays properties consistent with the credit risk puzzle. Using transactions from January 2004 to December 2011, I find that liquidity costs display a strong correlation with credit conditions and peaked during the subprime crisis. After controlling for equity volatility with high-frequency measures, liquidity costs explain a substantial fraction of the variation in the yield spreads of highly rated bonds, but become less important for speculative-grade bonds.

Keywords: liquidity, credit risk, realized volatility, stochastic friction, TRACE

JEL Classification: C11, G12

Suggested Citation

Rossi, Marco, Realized Volatility, Liquidity, and Corporate Yield Spreads (January 3, 2014). Available at SSRN: https://ssrn.com/abstract=1571437 or http://dx.doi.org/10.2139/ssrn.1571437

Marco Rossi (Contact Author)

Texas A&M ( email )

360S Wehner
College Station, TX 77843-4218
United States

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