An asset pricing approach to liquidity effects in corporate bond markets

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 effectsexplain 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.

Netspar, Network for Studies on Pensions, Aging and Retirement, is a thinktank and knowledge network. Netspar is dedicated to promoting a wider understanding of the economic and social implications of pensions, aging and retirement in the Netherlands and Europe.

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