Size-Adapted Bond Liquidity Measures and Their Asset Pricing Implications

2020 AFA, 2019 FMA, 2018 SAFE Asset Pricing Workshop

57 Pages Posted: 11 Apr 2019 Last revised: 18 Dec 2020

See all articles by Michael Reichenbacher

Michael Reichenbacher

Karlsruhe Institute of Technology (KIT), Institute for Finance

Philipp Schuster

University of Stuttgart, Institute of Business Administration

Date Written: December 18, 2020

Abstract

We develop new liquidity measures for bond markets. Existing measures suffer from the combination of two effects. First, transaction costs in OTC markets strongly depend on trade size. Second, many bonds trade only scarcely with strongly differing trading volumes. Therefore, changes in average transaction costs often indicate changing trade sizes rather than changing liquidity. We combine full-sample information for the size-cost relation with individual transaction data to eliminate such measurement problems. Exploiting their higher measurement precision, our size-adapted measures uncover the joint pricing of liquidity level and liquidity risk in the cross-section of U.S.
corporate bonds.

Keywords: bond liquidity, transaction costs, bid-ask spread, trade size, asset pricing, rating downgrades

JEL Classification: C10, C14, G11, G12, G14

Suggested Citation

Reichenbacher, Michael and Schuster, Philipp, Size-Adapted Bond Liquidity Measures and Their Asset Pricing Implications (December 18, 2020). 2020 AFA, 2019 FMA, 2018 SAFE Asset Pricing Workshop, Available at SSRN: https://ssrn.com/abstract=3366298 or http://dx.doi.org/10.2139/ssrn.3366298

Michael Reichenbacher (Contact Author)

Karlsruhe Institute of Technology (KIT), Institute for Finance ( email )

Kaiserstraße 12
Karlsruhe, Baden Württemberg 76131
Germany

Philipp Schuster

University of Stuttgart, Institute of Business Administration ( email )

Keplerstraße 17
D-70174 Stuttgart
Germany
+49 711 685-86001 (Phone)

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