Idiosyncratic Bond Volatility and Funding Liquidity

82 Pages Posted: 25 Aug 2021 Last revised: 2 Aug 2022

See all articles by Jie Cao

Jie Cao

The Hong Kong Polytechnic University - School of Accounting and Finance

Tarun Chordia

Emory University - Department of Finance

Linyu (Lucy) Zhou

The Chinese University of Hong Kong (CUHK) - Department of Finance

Date Written: July 30, 2021

Abstract

This paper documents a positive cross-sectional relation between returns and lagged idiosyncratic volatility (IVOL) in the corporate bond market. The relation obtains following periods of low funding liquidity due to a funding liquidity driven decrease in contemporaneous returns followed by a return reversal in the high IVOL bonds. Three exogenous shocks, (i) the Volcker Rule which restricted the participation of dealers in the corporate bond market in 2014, (ii) the Global Financial Crisis of 2008, and (iii) the COVID-19 crisis of 2020, are used to establish the causality between funding liquidity and the positive cross-sectional IVOL-return relation.

Keywords: Corporate bonds, idiosyncratic volatility, financial intermediaries, Volcker Rule, COVID-19

JEL Classification: G10, G11, G12, E44

Suggested Citation

Cao, Jie and Chordia, Tarun and Zhou, Linyu, Idiosyncratic Bond Volatility and Funding Liquidity (July 30, 2021). Available at SSRN: https://ssrn.com/abstract=3896084 or http://dx.doi.org/10.2139/ssrn.3896084

Jie Cao

The Hong Kong Polytechnic University - School of Accounting and Finance ( email )

Hung Hom, Kowloon
Hong Kong

HOME PAGE: http://sites.google.com/site/jiejaycao

Tarun Chordia (Contact Author)

Emory University - Department of Finance ( email )

Atlanta, GA 30322-2710
United States
404-727-1620 (Phone)
404-727-5238 (Fax)

Linyu Zhou

The Chinese University of Hong Kong (CUHK) - Department of Finance ( email )

Shatin, N.T.
Hong Kong

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