Stock Liquidity and Corporate Bond Yield Spreads: Theory and Evidence
57 Pages Posted: 26 Dec 2014 Last revised: 18 Mar 2016
Date Written: December 25, 2014
We examine the impact of individual stock liquidity on corporate bond yield spreads in the U.S. market. By extending the endogenous-default model to include stock liquidity in the calculation of the bond value we show that a drop in stock liquidity will increase the firm’s credit risk by increasing the firm’s default boundary, leading to an increase of the credit spread. Our model is consistent with the sharp increase of credit risk premiums and the “yield spread spike” phenomenon in corporate bond markets during the financial crisis. We present empirical evidence supportive of our model.
JEL Classification: G12, G33
Suggested Citation: Suggested Citation