Corporate Bond Illiquidity: Evidence from Government Guarantees

Abstract

We use a matched sample of corporate bonds that are guaranteed by the full faith and credit of the U.S. government and non-guaranteed corporate bonds of the same issuers to examine default and non-default related components in bond spreads. We find that less than one-fifth of the yield spread between short-term, investment grade corporate bonds and Treasury securities is compensation for illiquidity. Our estimates of the liquidity component in corporate bond spreads differ significantly from the bond-CDS basis. We also find evidence that the corporate bond bid-ask spread is largely related to credit risk.

Keywords: Liquidity, Credit Risk, Corporate Bonds, Government Guarantees

JEL Classification: G12, G18