Liquidity Premium in the Eye of the Beholder: An Analysis of the Clientele Effect in the Corporate Bond Market

Abstract

This paper examines how liquidity and investors' heterogeneous liquidity preferences interact to affect asset pricing. We construct measures of liquidity preferences using data on insurer corporate bond holdings, and find that investors' preferences are highly persistent over time and related to investment horizons and funding constraints. We provide evidence that investors vary widely in their preferences and, more importantly, evidence for liquidity clientele. Further, we find evidence that liquidity clienteles affect corporate bond prices --- specifically, both the level and volatility of liquidity premia are substantially attenuated among corporate bonds heavily held by investors with a weak preference for liquidity.

Keywords: Corporate Bond Holdings, Liquidity Clientele, Corporate Bond Liquidity and Spreads

JEL Classification: G01, G12, G22, C23