Bond Misallocation and Liquidity Risk

51 Pages Posted: 20 Aug 2020

See all articles by Shuo Liu

Shuo Liu

Tsinghua University - School of Economics & Management

Date Written: July 17, 2020


Which corporate bond's yield is more exposed to search frictions? Is the exposure correlated with dealers' inter-mediation? We propose a measure of bond's mis-allocation among dealers and show its correlation with bond's liquidity risk which is attributed to search frictions. This measure is defined as the cross-sectional covariance of dealers' private valuations for a bond and their corresponding inventory positions. Using a transaction-level dataset on U.S. corporate bonds, we verify: a higher mis-allocation is associated with a higher magnitude of liquidity risk. A search-match model with dealers' endogenous search efforts offers an explanation on this correlation.

Keywords: corporate bond market, bond mis-allocation, liquidity risk, search frictions

JEL Classification: G10, G12, G20

Suggested Citation

Liu, Shuo, Bond Misallocation and Liquidity Risk (July 17, 2020). Available at SSRN: or

Shuo Liu (Contact Author)

Tsinghua University - School of Economics & Management ( email )

Beijing, 100084

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