Market transparency, liquidity externalities, and institutional trading costs in corporate bonds☆

Bessembinder, Hendrik; Maxwell, William F.; Venkataraman, Kumar

doi:10.1016/j.jfineco.2005.10.002

Cited by 498 publications

(256 citation statements)

References 32 publications

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“…The second is a regressionbased methodology where each transaction price is regressed on a benchmark price and a buy/sell indicator (Schultz (2001), Bessembinder et al (2006), Goldstein et al (2007), and Edwards et al (2007)). However, both approaches require a buy/sell indicator for each trade, which is not publicly available for most of the sample.…”

Section: Estimation Methodologymentioning

confidence: 99%

The Same Bond at Different Prices: Identifying Search Frictions and Selling Pressures

Feldhütter¹

2011

Rev. Financ. Stud.

352

113

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I model how corporate bond prices are affected by search frictions and occasional selling pressures and test my predictions empirically. A key prediction is that in a distressed market with more sellers than buyers, prices paid by institutional investors decrease more than those of retail investors. Using a structural estimation, the model is able to identify liquidity crises (i.e. high number of forced sellers) based on the relative prices of institutional and retail investors. New light is shed on two crises, the downgrade of GM and Ford in 2005 and the current crisis. The model also explains why the spread between corporate bond yields and Treasury yields is so large, the so-called credit spread puzzle. * I am very grateful to David Lando and Lasse Heje Pedersen for many helpful comments and discussions and to Jens Dick-Nielsen for discussions regarding the TRACE database. I also thank Viral

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Section: Estimation Methodologymentioning

confidence: 99%

The Same Bond at Different Prices: Identifying Search Frictions and Selling Pressures

Feldhütter¹

2011

Rev. Financ. Stud.

352

113

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“…The overall effect is unclear and worth exploring in future research. 6 As documented by a series of empirical papers (e.g., Bessembinder, Maxwell, and Venkataraman (2006), Edwards, Harris, and Piwowar (2007), Mahanti et al (2008), and Bao, Pan, and Wang (2011)), the secondary markets for corporate bonds are highly illiquid. The illiquidity is reflected attribute this cost to either the market impact of the trade (e.g., Kyle (1985)), or the bid-ask spreads charged by bond dealers (e.g., Glosten and Milgrom (1985)).…”

Section: Secondary Bond Marketsmentioning

confidence: 99%

Rollover Risk and Credit Risk

Xiong

2011

SSRN Journal

101

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Our model shows that deterioration in debt market liquidity leads to an increase in not only the liquidity premium of corporate bonds but also credit risk. The latter effect originates from firms' debt rollover. When liquidity deterioration causes a firm to suffer losses in rolling over its maturing debt, equity holders bear the losses while maturing debt holders are paid in full. This conflict leads the firm to default at a higher fundamental threshold. Our model demonstrates an intricate interaction between the liquidity premium and default premium and highlights the role of short-term debt in exacerbating rollover risk.THE YIELD SPREAD OF a firm's bond relative to the risk-free interest rate directly determines the firm's debt financing cost, and is often referred to as its credit spread. It is widely recognized that the credit spread reflects not only a default premium determined by the firm's credit risk but also a liquidity premium due to illiquidity of the secondary debt market (e.g., Longstaff, Mithal, and Neis (2005) and Chen, Lesmond, and Wei (2007)). However, academics and policy makers tend to treat both the default premium and the liquidity premium as independent, and thus ignore interactions between them. The financial crisis of 2007 to 2008 demonstrates the importance of such an interactiondeterioration in debt market liquidity caused severe financing difficulties for many financial firms, which in turn exacerbated their credit risk.In this paper, we develop a theoretical model to analyze the interaction between debt market liquidity and credit risk through so-called rollover risk: when debt market liquidity deteriorates, firms face rollover losses from issuing new bonds to replace maturing bonds. To avoid default, equity holders need to bear the rollover losses, while maturing debt holders are paid in full. This

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“…The recent literature on transaction costs contains several different approaches for estimating transaction costs. Bessembinder, Maxwell, and Venkataraman (2006) use data reported by insurance companies to the National Association of Insurance Companies to estimate round-trip transaction costs for a limited set of bonds using a signed-variable approach. Using the same dataset, Goldstein, Hotchkiss, and Sirri (2005) establish that transaction costs have decreased after the introduction of reporting on TRACE.…”

Section: Latent Liquidity and Transaction Costsmentioning

confidence: 99%

“…2 Recently, attempts have been made to accurately quantify transaction costs in the market. Bessembinder, Maxwell, and Venkataraman (2006) use National Association of Insurance Commissioners (NAIC) data to estimate round-trip transaction costs for a limited set of bonds using a signed-variable approach. Using the same dataset, Goldstein, Hotchkiss, and Sirri (2005) establish that transaction costs have decreased after the introduction of centralized reporting of transactions by the National Association of Securities Dealers (NASD) in 2002.…”

Section: Introductionmentioning

confidence: 99%

Latent liquidity: A new measure of liquidity, with an application to corporate bonds

Mahanti¹,

Nashikkar

Subrahmanyam

et al. 2008

Journal of Financial Economics

199

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We present a new measure of liquidity known as ''latent liquidity'' and apply it to a unique corporate bond database. Latent liquidity is defined as the weighted average turnover of investors who hold a bond, in which the weights are the fractional investor holdings. It can be used to measure liquidity in markets with sparse transactions data. For bonds that trade frequently, our measure has predictive power for both transaction costs and the price impact of trading, over and above trading activity and bond-specific characteristics thought to be related to liquidity. Additionally, this measure exhibits relationships with bond characteristics similar to those of other trade-based measures. r

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Market transparency, liquidity externalities, and institutional trading costs in corporate bonds☆

Cited by 498 publications

References 32 publications

The Same Bond at Different Prices: Identifying Search Frictions and Selling Pressures

The Same Bond at Different Prices: Identifying Search Frictions and Selling Pressures

Rollover Risk and Credit Risk

Latent liquidity: A new measure of liquidity, with an application to corporate bonds

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