Search Friction, Liquidity Risk and Bond Misallocation

74 Pages Posted: 14 Sep 2023

See all articles by Shuo Liu

Shuo Liu

Tsinghua University - Tsinghua University School of Economics and Management

Abstract

Search friction is a key driver of changes in corporate bond yield spreads over time. In the cross-section, the liquidity risk stemming from search friction is significantlypriced, and is strongly correlated with the misallocation of bond positions among different traders. To capture this dispersion, we propose a novel measure of bond-specific misallocation, which is the negative covariance between traders’ private valuations and their inventory positions for each bond. We find that bonds with higher levels of misallocation are associated with lower absolute levels of liquidity risk from search friction. We develop a search-and-match model to explain this correlation.

Keywords: Corporate bond market, Bond misallocation, Liquidity risk, Search friction

Suggested Citation

Liu, Shuo, Search Friction, Liquidity Risk and Bond Misallocation. Available at SSRN: https://ssrn.com/abstract=4572076 or http://dx.doi.org/10.2139/ssrn.4572076

Shuo Liu (Contact Author)

Tsinghua University - Tsinghua University School of Economics and Management ( email )

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
18
Abstract Views
123
PlumX Metrics