Liquidity Risk Premia in Corporate Bond Markets. Working Paper

Liquidity Risk Premia in Corporate Bond Markets. Working Paper (2005)

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by Frank De Jong , Joost Driessen

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@MISC{Jong05liquidityrisk,
    author = {Frank De Jong and Joost Driessen},
    title = {Liquidity Risk Premia in Corporate Bond Markets. Working Paper},
    year = {2005}
}

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Abstract

This paper explores the role of liquidity risk in the pricing of corporate bonds. We show that corporate bond returns have significant 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. ∗ We are grateful to Inquire Europe for financial support. We thank Viral Acharya, Michael

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