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Liquidity And Its Impact On Bond Prices

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  • Alexander Kempf
  • Marliese Uhrig-Homburg

Abstract

In this paper, we propose a theoretical continuous-time model to analyze the impact of liquidity on bond prices. This model prices illiquid bonds relative to liquid bonds and provides a testable theory of illiquidity induced price discounts. The model is tested using 1992–1994 data from bonds issued by the German government. These bonds define a market segment that is homogeneous in bankruptcy risk, taxes, age, and coupons, but the bonds differ with respect to their liquidity. The empirical findings suggest that bond prices not only depend on the dynamics of interest rates, but also on the liquidity of bonds. Therefore, bond liquidity should be used as an additional pricing factor. The findings of the out-of-sample test demonstrate the superiority of the model in comparison with traditional pricing models.

Suggested Citation

  • Alexander Kempf & Marliese Uhrig-Homburg, 2000. "Liquidity And Its Impact On Bond Prices," Schmalenbach Business Review (sbr), LMU Munich School of Management, vol. 52(1), pages 26-44, January.
  • Handle: RePEc:sbr:abstra:v:52:y:2000:i:1:p:26-44
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    Cited by:

    1. Houweling, Patrick & Mentink, Albert & Vorst, Ton, 2005. "Comparing possible proxies of corporate bond liquidity," Journal of Banking & Finance, Elsevier, vol. 29(6), pages 1331-1358, June.
    2. Marc Chesney & Alexander Kempf, 2012. "The value of tradeability," Review of Derivatives Research, Springer, vol. 15(3), pages 193-216, October.
    3. repec:eee:quaeco:v:66:y:2017:i:c:p:265-274 is not listed on IDEAS

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