We use an asset pricing approach to compare the effects of expected liquidity and liquidity risk on expected U.S. corporate bond returns. Liquidity measures are constructed for bond portfolios using a Bayesian approach to estimate Roll’s measure. The results show that expected bond liquidity and exposure to equity market liquidity risk affect expected bond returns, and that these liquidity effects explain a substantial part of the credit spread puzzle. In contrast, we find robust evidence that exposure to corporate bond liquidity shocks carries an economically negligible risk premium. We develop a simple theoretical model that can explain this finding.
- Liquidity premium
- liquidity risk
- corporate bonds
- credit spread puzzle
Bongaerts, D., de Jong, F., & Driessen, J. (2017). An asset pricing approach to liquidity effects in corporate bond markets. The Review of Financial Studies, 30(4), 1229-1269. https://doi.org/10.1093/rfs/hhx005