Corporate Bond Liquidity Before and after the Onset of the Subprime Crisis

Abstract

a b s t r a c tWe analyze liquidity components of corporate bond spreads during 2005-2009 using a new robust illiquidity measure. The spread contribution from illiquidity increases dramatically with the onset of the subprime crisis. The increase is slow and persistent for investment grade bonds while the effect is stronger but more short-lived for speculative grade bonds. Bonds become less liquid when financial distress hits a lead underwriter and the liquidity of bonds issued by financial firms dries up under crises. During the subprime crisis, flight-to-quality is confined to AAA-rated bonds.

The pricing of different dimensions of liquidity: Evidence from government guaranteed bonds

“…We find that each of the three dimensions of market-wide liquidity has significant pricing relevance over our full sample period. When we control for the possibility of different liquidity pricing relationships during the financial crisis (as suggested by Dick-Nielsen, et al (2012) and Friewald, Jankowitsch, and, Subrahmanyam (2012)), we find that only the market-wide trading cost dimension is significantly priced during the crisis, in addition to bond-specific resiliency and bond-specific trading costs. However, in the post-crisis subsample, each of the three bond-specific and market-wide liquidity dimensions is significantly priced.…”

“…For equity markets, Brennan and Subrahmanyam (1996) document that an estimate of Kyle's λ -the depth dimension -is a priced risk factor in equities. In the bond market, Dick-Nielsen, et al (2012) find that the Amihud (2002) measure of depth is priced in the non-default spread.…”

“…Similar to Dick-Nielsen, et al (2012) we use the Amihud (2002) illiquidity measure as a proxy for price impact of trades, and thus the depth dimension of liquidity. We estimate the Amihud measure as the following:…”

Cash flow volatility and corporate bond yield spreads

“…9 If both rating agencies rate a bond, we use the average of the two ratings. 5 An alternative would be to use the Trade Reporting and Compliance Engine (TRACE) data; see, for example, Dick-Nielsen (2009) andDick-Nielsen et al (2012). This has the advantage of including all transactions, not just those by insurers.…”

“…To address this problem, we manually sort through each entry by checking the company name in FISD against the company name in Compustat and then eliminate those entries whose names do not match. 8 Some papers that use TRACE data also adopt similar data filtering procedures (e.g., Dick-Nielsen et al 2012). 9 Campbell and Taksler (2003) eliminate AAA (or Aaa) rated bonds because the NAIC data for these issues appears to be somewhat problematic for the early years of the sample, with average yields for these bonds exceeding those of lower rated bonds.…”