Liquidity Risk Premia in Corporate Bond Markets

47 Pages Posted: 8 Apr 2005 Last revised: 7 May 2009

Frank De Jong

Tilburg University - Department of Finance

Joost Driessen

Tilburg University - Department of Finance; CentER Tilburg University

Date Written: September 22, 2006

Abstract

This paper explores the role of liquidity risk in the pricing of corporate bonds. We show that corporate bond returns have signifcant exposures to fluctuations in treasury bond liquidity and equity market liquidity. Further, this liquidity risk is a priced factor for the expected returns on corporate bonds, and the associated liquidity risk premia help to explain the credit spread puzzle. In terms of expected returns, the total estimated liquidity risk premium is around 0.6% per annum for US long-maturity investment grade bonds. For speculative grade bonds, which have higher exposures to the liquidity factors, the liquidity risk premium is around 1.5% per annum. We find very similar evidence for the liquidity risk exposure of corporate bonds for a sample of European corporate bond prices.

Keywords: Credit spread, liquidity premium

JEL Classification: G12, G13

Suggested Citation

De Jong, Frank and Driessen, Joost, Liquidity Risk Premia in Corporate Bond Markets (September 22, 2006). Available at SSRN: https://ssrn.com/abstract=686681 or http://dx.doi.org/10.2139/ssrn.686681

Frank De Jong

Tilburg University - Department of Finance ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Joost Driessen (Contact Author)

Tilburg University - Department of Finance ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

CentER Tilburg University ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

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