Corporate Yield Spreads and Bond Liquidity

42 Pages Posted: 7 Feb 2004  

David A. Lesmond

Tulane University - A.B. Freeman School of Business

Long Chen

Cheung Kong Graduate School of Business

Jason Zhanshun Wei

University of Toronto - Rotman School of Management

Date Written: April 2005

Abstract

We examine whether liquidity is priced in corporate yield spreads. Using a battery of liquidity measures covering over 4000 corporate bonds and spanning investment grade and speculative grade categories, we find that more illiquid bonds earn higher yield spreads; and that an improvement of liquidity causes a significant reduction in yield spreads. These results hold after controlling for common bond-specific, firm-specific, and macroeconomic variables, and are robust to issuers' fixed effect and potential endogeneity bias. Our finding mitigates the concern in the default risk literature that neither the level nor the dynamic of yield spreads can be fully explained by default risk determinants, and suggests that liquidity plays an important role in corporate bond valuation.

Suggested Citation

Lesmond, David A. and Chen, Long and Wei, Jason Zhanshun, Corporate Yield Spreads and Bond Liquidity (April 2005). 14th Annual Conference on Financial Economics and Accounting. Available at SSRN: https://ssrn.com/abstract=495422 or http://dx.doi.org/10.2139/ssrn.495422

David A. Lesmond

Tulane University - A.B. Freeman School of Business ( email )

7 McAlister Drive
511 Goldring-Woldenberg Hall
New Orleans, LA 70118
United States
504-865-5665 (Phone)
504-865-6751 (Fax)

Long Chen (Contact Author)

Cheung Kong Graduate School of Business ( email )

Oriental Plaza, Tower E3
One East Chang An Avenue
Beijing, 100738
China

Jason Zhanshun Wei

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6
Canada
416-978-3698 (Phone)
416-971-3048 (Fax)

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