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Effects of Liquidity on the Nondefault Component of Corporate Yield Spreads: Evidence from Intraday Transactions Data

  • Song Han

    (Federal Reserve Board and Hong Kong Institute for Monetary Research)

  • Hao Zhou

    (Federal Reserve Board)

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We estimate the nondefault 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 nondefault 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 nondefault 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 nondefault component and illiquidity for investment-grade bonds but no significant relationship for speculative-grade bonds. We also find that the nondefault component comoves with indicators for macroeconomic conditions.

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Paper provided by Hong Kong Institute for Monetary Research in its series Working Papers with number 022011.

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Length: 49 pages
Date of creation: Jan 2011
Date of revision:
Handle: RePEc:hkm:wpaper:022011
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