Asset Pricing Tests of Infrequently Traded Securities: The Case of Municipal Bonds

Liquidity risk of corporate bond returns: A conditional approach

Yao-Tsung Chen, Chunchi Wu and Chung-Ying Yeh

The Review of Asset Pricing Studies, 2022, vol. 12, issue 3, 754-807

Abstract: Using a dynamic selection model, we obtain consistent and unbiased estimates of risk and returns for infrequently traded bonds and conduct the first comprehensive asset pricing test of municipal bonds using the multifactor approach. Correction for sample selection and infrequent trading problems results in substantially higher beta estimates. Besides conventional risk factors, illiquidity and taxes are important for the pricing of municipal bonds. Importantly, bond returns contain a significant liquidity risk premium. Failing to account for sample selection bias leads to erroneous inference on the magnitude of systematic risk and substantial underestimation of risk premiums. (JEL G12, G14)

Date: 2022
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Persistent link: https://EconPapers.repec.org/RePEc:oup:rasset:v:12:y:2022:i:3:p:754-807.

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