(Il)liquidity Premium in Credit Markets: A Myth?
45 Pages Posted: 6 Mar 2018 Last revised: 30 Aug 2018
Date Written: March 29, 2018
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: Suggested Citation