Search Friction, Liquidity Risk and Bond Mis-allocation

60 Pages Posted: 20 Aug 2020 Last revised: 26 May 2021

See all articles by Shuo Liu

Shuo Liu

Tsinghua University - School of Economics & Management

Date Written: July 17, 2020

Abstract

Systemic search friction is an important liquidity factor which drives all corporate bonds' yield spread changes. In cross section, bonds have different levels of this yield spread loading. To explain this cross-sectional heterogeneity, we propose a measure of bond-level misallocation among traders, which is defined as the covariance of traders' private valuation and inventory position for each bond. Using transaction-level data, we find that: bonds with a higher level of misallocation have a lower absolute value of yield spread loading on systemic search friction. This relationship is specific to the decentralized market structure, where transactions rely on traders’ searching activity.

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

JEL Classification: G10, G12, G21

Suggested Citation

Liu, Shuo, Search Friction, Liquidity Risk and Bond Mis-allocation (July 17, 2020). Available at SSRN: https://ssrn.com/abstract=3654674 or http://dx.doi.org/10.2139/ssrn.3654674

Shuo Liu (Contact Author)

Tsinghua University - School of Economics & Management ( email )

Beijing, 100084
China

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