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

Jeffrey R. Black, Duane Stock and Pradeep K. Yadav

No 15-10, CFR Working Papers from University of Cologne, Centre for Financial Research (CFR)

Abstract: Seminal market microstructure literature identifies at least three important dimensions of liquidity: trading costs, depth, and resiliency. We investigate the relevance of each of these three dimensions of liquidity - separately and in conjunction - for the pricing of corporate bonds. Unlike previous studies, our sample allows us to cleanly separate the default and non-default components of yield spreads. We find that each of the above three dimensions of liquidity impact non-default spreads, with trading costs and resiliency being more important than depth. We also find that both bond-specific and market-wide dimensions of liquidity are priced in non-default spreads. Finally, we find that, even though these three dimensions of liquidity account for virtually the entire non-default spread, there does exist in some periods a small residual non-default yield spread that is consistent with an additional "flight-to-extreme-liquidity" premium reflecting investor preference for assets that enable quickest possible disengagement from the market when necessary.

Date: 2015
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:cfrwps:1510

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