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Please use this identifier to cite or link to this item:
http://hdl.handle.net/2451/26378
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| Title: | Latent Liquidity and Corporate Bond Yield Spreads |
| Authors: | Nashikkar, Amrut
Subrahmanyam, Martin |
| Issue Date: | 14-Nov-2006 |
| Series/Report no.: | FIN-06-023 |
| Abstract: | Recent research has shown that default risk accounts for only a part of
the total yield spread on risky corporate bonds relative to their
riskless benchmarks. One candidate for the unexplained portion of the
spread is a premium for the illiquidity in the corporate bond market. We
investigate this issue by relating the liquidity of corporate bonds, as
measured by their ease of market access, to the non-default component of
their respective corporate bond yields using the portfolio holdings
database of the largest custodian in the market. The ease of access of a
bond is measured using a recently developed measure called latent
liquidity that weights the turnover of funds holding the bond by their
fractional holdings of the bond. We use the credit default swap (CDS)
prices of the bond issuer to control for the credit risk of a bond. At
an aggregate level, we find a contemporaneous relationship between
aggregate latent liquidity and the average non-default component in
corporate bond yields. Additionally, for individual bonds, we find that
bonds with higher latent liquidity have a lower non-default component of
their yield spread. We also document that bonds that are held by funds
that exhibit greater buying activity command lower spreads (i.e., are
more expensive), while the opposite is true for those that exhibit
greater selling activity. We also find that the liquidity in the CDS
market has an impact on bond pricing, over and above bond-specific
liquidity effects. |
| URI: | http://hdl.handle.net/2451/26378 |
| Appears in Collections: | Finance Working Papers
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