Feedback Between Credit and Liquidity Risk in the US Corporate Bond Market

81 Pages Posted: 8 Jun 2017 Last revised: 20 Oct 2017

See all articles by Rob C. Sperna Weiland

Rob C. Sperna Weiland

University of Amsterdam Business School; Tinbergen Institute

Roger J. A. Laeven

University of Amsterdam - Department of Quantitative Economics (KE)

Frank De Jong

Tilburg University - Department of Finance

Date Written: October 20, 2017

Abstract

We analyze the dynamic interactions between credit and liquidity risk and their impact on bond prices and risk. We propose a novel way of modeling credit-liquidity interactions through mutually exciting processes and develop a corresponding Bayesian estimation procedure. Using US corporate bond transaction data, we show that there is evidence of feedback between credit and liquidity risk and that this feedback is stronger for lower-rated bonds. We find that, on average, the credit-induced liquidity component accounts for 8% (AAA/AA) to 17% (B and lower) of total yield spreads, but in the most distressed periods it can account for over 40%.

Keywords: Credit risk, Liquidity risk, Corporate bonds, Mutually exciting processes, Jumps, MCMC

JEL Classification: C11, C58, G12

Suggested Citation

Sperna Weiland, Rob C. and Laeven, Roger Jean Auguste and De Jong, Frank, Feedback Between Credit and Liquidity Risk in the US Corporate Bond Market (October 20, 2017). 30th Australasian Finance and Banking Conference 2017. Available at SSRN: https://ssrn.com/abstract=2982319 or http://dx.doi.org/10.2139/ssrn.2982319

Rob C. Sperna Weiland (Contact Author)

University of Amsterdam Business School ( email )

Roetersstraat 18
Amsterdam, 1018WB
Netherlands

Tinbergen Institute ( email )

Gustav Mahlerplein 117
Amsterdam, 1082 MS
Netherlands

Roger Jean Auguste Laeven

University of Amsterdam - Department of Quantitative Economics (KE) ( email )

Valckenierstraat 65-67
Amsterdam, 1018 XE
Netherlands
+31 20 525 4252 (Phone)

HOME PAGE: http://www.rogerlaeven.com

Frank De Jong

Tilburg University - Department of Finance ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

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