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

Author

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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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    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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