Asymmetry in Liquidity Pricing in the Cross-Section and Time Series of Corporate Bond Returns

Abstract

Asymmetry in price pressure from seller versus buyer-initiated transactions is a valuable measure of downside liquidity for corporate bonds. Larger relative price impact of sellers can exacerbate market downturns in flight-to-liquidity environments. While the evidence of an illiquidity characteristics premium in the cross-section of corporate bonds is mixed, aggregate liquidity asymmetry has high explanatory power for the time series of market returns. Its statistical and economic significance justify it as credible asset pricing factor. Average market-wide liquidity asymmetry comoves with interest rate and credit spread changes, investor sentiment, funding liquidity, dealer inventory, ETF flows and post-crisis regulatory change.

Keywords: Liquidity; Liquidity risk; Downside risk; Asset pricing; Corporate bonds

JEL Classification: D82; G11; G12; G14