Investor Concentration, Liquidity and Bond Price Dynamics

Abstract

We find that investor concentration plays a vital role in influencing corporate bond pricing dynamics and liquidity, even when controlling for the distribution of different investor types. First, we observe a significant level of concentration in the corporate bond market, with a median of just 47 investors for U.S. investment-grade bonds. Additionally, there is notable variation in investor concentrations across bonds within a single firm. We then show that bonds with lower investor concentration are more liquid. Furthermore, during periods of financial stress, bonds with less concentrated investor bases experience more substantial price drops on impact but subsequently recover more rapidly. Notably, a one standard deviation increase in investor concentration is linked to a 120 basis points decrease in drawdown during the Great Recession and a 94 basis points decrease in drawdown during the COVID-19 crisis. We explain our findings by extending the dynamic model of Vayanos(1999) to incorporate multiple risky assets and heterogeneous investors with different risk aversion. Our findings shed new light on how investor concentration affects liquidity and price dynamics in illiquid asset markets.

Keywords: Investor Concentration; Liquidity; Corporate Bond; COVID-19 Crisis; Price Dynamics

JEL Classification: G12; G22; G23