(Il)liquidity Premium in Credit Markets: A Myth?

45 Pages Posted: 6 Mar 2018 Last revised: 30 Aug 2018

See all articles by Diogo Palhares

Diogo Palhares

AQR Capital Management, LLC

Scott A. Richardson

AQR Capital Management, LLC; London Business School

Date Written: March 29, 2018

Abstract

Across multiple measures of “liquidity” and a variety of methods to control for correlated characteristics of more (less) liquid bonds, we find only limited evidence of a liquidity premium in the cross section of corporate bonds. Specifically, while illiquid bonds have slightly higher credit spreads and directionally higher average returns, portfolios that tilt toward (away from) less (more) liquid bonds exhibit considerably higher levels of volatility. Economically, the low Sharpe ratios of illiquidity-factor-mimicking portfolios are hard to justify for an investor. This is puzzling, as theory suggests investors should demand a risk premium for holding less-liquid assets.

Keywords: corporate bonds, liquidity, risk premium

JEL Classification: G12, G14, M41

Suggested Citation

Palhares, Diogo and Richardson, Scott Anthony, (Il)liquidity Premium in Credit Markets: A Myth? (March 29, 2018). Journal of Fixed Income, Forthcoming. Available at SSRN: https://ssrn.com/abstract=3130213 or http://dx.doi.org/10.2139/ssrn.3130213

Diogo Palhares (Contact Author)

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

Scott Anthony Richardson

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

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