Liquidity and Credit Risk

Jan Ericsson and Olivier RENAULT
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Olivier RENAULT: London School of Economics

FAME Research Paper Series from International Center for Financial Asset Management and Engineering

Abstract: We develop a simple binomial model of liquidity and credit risk in which a bondholder has the option to time the sale of his security, given a distribution of potential buyers, bids and liquidity shocks. We examine first the case without default and find that our model predicts decreasing term structures of liquidity premia, consistent with empirical evidence. In the default risky case, we find that liquidity spreads are positively related to credit risk. Using a sample of US corporate bonds, we find support for the time to maturity effect and the positive correlation between credit and liquidity spreads.

JEL-codes: G12 G13 (search for similar items in EconPapers)
Date: Written

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http://www.swissfinanceinstitute.ch/rp42.pdf (application/pdf)

Related works:
Working Paper: Liquidity and Credit Risk (2000)
Journal Article: Liquidity and Credit Risk (2006)
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Persistent link: http://EconPapers.repec.org/RePEc:fam:rpseri:rp42

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