Search friction, liquidity risk, and bond misallocation

Shuo Liu

Journal of Financial Markets, 2024, vol. 70, issue C

Abstract: Search friction is a key driver of changes in corporate bond yield spreads over time. In the cross-section, the liquidity risk stemming from search friction is significantly priced, and is strongly correlated with the misallocation of bond positions among different traders. I propose a novel measure of bond-specific misallocation, which is the negative covariance between traders’ private valuations and their inventory positions for each bond. I find that bonds with higher levels of misallocation are associated with lower absolute levels of liquidity risk from search friction. I develop a search-and-matching model to explain this correlation.

Keywords: Corporate bond market; Bond misallocation; Liquidity risk; Search friction (search for similar items in EconPapers)
JEL-codes: G10 G12 G21 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finmar:v:70:y:2024:i:c:s1386418124000302

DOI: 10.1016/j.finmar.2024.100912

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