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Effects of Liquidity on the Non-Default Component of Corporate Yield Spreads: Evidence from Intraday Transactions Data

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  • Song Han

    (Short-Term Funding Markets Section, Division of Research and Statistics, Federal Reserve Board, Mail Stop 89, Washington, DC 20551, USA)

  • Hao Zhou

    () (PBC School of Finance, Tsinghua University, 43 ChengFu Road, Haidian District 100083, PR China)

Abstract

We estimate the non-default component of corporate bond yield spreads and examine its relationship with bond liquidity. We measure bond liquidity using intraday transactions data and estimate the default component using the term structure of credit default swaps (CDS) spreads. With swap rate as the risk free rate, the estimated non-default component is generally moderate but statistically significant for AA-, A-, and BBB-rated bonds and increasing in this order. With Treasury rate as the risk free rate, the estimated non-default component is the largest in basis points for BBB-rated bonds but, as a fraction of yield spreads, it is the largest for AAA-rated bonds. Controlling for the unobservable firm heterogeneity, we find a positive and significant relationship between the non-default component and illiquidity for investment-grade bonds but no significant relationship for speculative-grade bonds. We also find that the non-default component comoves with indicators for macroeconomic conditions.

Suggested Citation

  • Song Han & Hao Zhou, 2016. "Effects of Liquidity on the Non-Default Component of Corporate Yield Spreads: Evidence from Intraday Transactions Data," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 6(03), pages 1-49, September.
  • Handle: RePEc:wsi:qjfxxx:v:06:y:2016:i:03:n:s2010139216500129
    DOI: 10.1142/S2010139216500129
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    7. Anténor-Habazac, Cassandre & Dionne, Georges & Guesmi, Sahar, 2018. "Cyclical variations in liquidity risk of corporate bonds," Working Papers 18-3, HEC Montreal, Canada Research Chair in Risk Management.
    8. Díaz, Antonio & Escribano, Ana, 2020. "Measuring the multi-faceted dimension of liquidity in financial markets: A literature review," Research in International Business and Finance, Elsevier, vol. 51(C).
    9. Allaudeen Hameed & Jean Helwege & Ran Li & Frank Packer, 2019. "Measuring corporate bond liquidity in emerging market economies: price- vs quantity-based measures," BIS Papers chapters, in: Bank for International Settlements (ed.), Asia-Pacific fixed income markets: evolving structure, participation and pricing, volume 102, pages 45-62, Bank for International Settlements.
    10. Arnold, Marc & Wagner, Alexander F. & Westermann, Ramona, 2013. "Growth options, macroeconomic conditions, and the cross section of credit risk," Journal of Financial Economics, Elsevier, vol. 107(2), pages 350-385.
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    13. Kucuk, Ugur N., 2010. "Non-default Component of Sovereign Emerging Market Yield Spreads and its Determinants: Evidence from Credit Default Swap Market," MPRA Paper 27428, University Library of Munich, Germany.
    14. Kalimipalli, Madhu & Nayak, Subhankar & Perez, M. Fabricio, 2013. "Dynamic effects of idiosyncratic volatility and liquidity on corporate bond spreads," Journal of Banking & Finance, Elsevier, vol. 37(8), pages 2969-2990.
    15. Dick-Nielsen, Jens & Feldhütter, Peter & Lando, David, 2012. "Corporate bond liquidity before and after the onset of the subprime crisis," Journal of Financial Economics, Elsevier, vol. 103(3), pages 471-492.
    16. Hilscher, Jens & Pollet, Joshua M. & Wilson, Mungo, 2015. "Are Credit Default Swaps a Sideshow? Evidence That Information Flows from Equity to CDS Markets," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 50(3), pages 543-567, June.
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    More about this item

    Keywords

    Corporate bond yield spreads; credit default swaps; liquidity; CDS-bond basis;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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