Illiquidity premiums in international corporate bond markets

Abstract

This article examines the impact of illiquidity levels on corporate bond pricing with a novel international dataset, including both advanced and emerging economies. Results show that less liquid corporate bonds which possess wider bid-ask spreads display higher expected returns and credit spreads globally. However, after controlling for common risk factors, illiquidity premiums remain significant exclusively in emerging markets, where investing in less liquid corporate bonds can generate sizable abnormal returns both before and after transaction costs. We further show that money-market liquidity, capital-account openness, and financial stability can contribute to cross-country differences in illiquidity premiums.

Keywords: corporate bonds, liquidity level, liquidity premium, emerging markets, credit spreads

JEL Classification: G12,G15