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Liquidity Risk Premia in Corporate Bond Markets

Author

Listed:
  • Frank de Jong

    (Finance Department, Tilburg University, P.O. Box 90153, 5000 LE, Tilburg, Netherlands)

  • Joost Driessen

    (Finance Department, Tilburg University, P.O. Box 90153, 5000 LE, Tilburg, Netherlands)

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.

Suggested Citation

  • Frank de Jong & Joost Driessen, 2012. "Liquidity Risk Premia in Corporate Bond Markets," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 2(02), pages 1-34.
    • Handle: RePEc:wsi:qjfxxx:v:02:y:2012:i:02:n:s2010139212500061
    DOI: 10.1142/S2010139212500061
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    References listed on IDEAS

    as
    1. Michael J. Fleming, 2003. "Measuring treasury market liquidity," Economic Policy Review, Federal Reserve Bank of New York, issue Sep, pages 83-108.
    2. Patrick Houweling & Albert Mentink & Ton Vorst, 2003. "How to measure Corporate Bond Liquidity?," Tinbergen Institute Discussion Papers 03-030/2, Tinbergen Institute.
    3. Goldreich, David & Hanke, Bernd & Nath, Purnendu, 2003. "The Price of Future Liquidity: Time-Varying Liquidity in the US Treasury Market," CEPR Discussion Papers 3900, C.E.P.R. Discussion Papers.
    4. Jeffery D Amato & Eli M Remolona, 2003. "The credit spread puzzle," BIS Quarterly Review, Bank for International Settlements, December.
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