Proposing Credit- and Sensitivity-Risk-Based Methodology to Address Corporate Bond Illiquidity Problem

Ruchi Arora () and Rishi Mehra
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Ruchi Arora: Birla Institute of Management Technology, Greater Noida 201306, India
Rishi Mehra: Arun Jaitley National Institute of Financial Management, Faridabad 121001, India

JRFM, 2023, vol. 16, issue 9, 1-17

Abstract: The current study explores the problem of illiquidity in the corporate bond market globally and proposes a solution to enhance liquidity by studying various dimensions of liquidity. Purpose: The purpose of this paper is to propose a solution to the global issue of illiquidity in the corporate bond market. The problem has been identified by many researchers and this paper attempts to find a viable solution in the “fungibility route” as an alternative to the “liquidity route”. Design/Methodology: An analysis of a sample size of 234,772 trade data of corporate bonds and a sample size of 2,00,607 trade data of G-securities is performed to identify the problem. Findings/Solution proposed: A mathematical model based on the credit risk differential and sensitivity differential is proposed to find out the fair value at which an illiquid bond can be exchanged with a liquid bond. To arrive at the fair value of the illiquid bond, we have calculated the risk-adjusted yield (RAY) using the modified duration and a credit risk differential. Originality: This research is a pioneering effort in addressing the worldwide issue of corporate bond illiquidity by proposing a novel solution. The proposed strategy aims to improve the liquidity of the bond indirectly, by utilizing the fungibility route.

Keywords: corporate bond market; bond liquidity; secondary bond market; credit risk; modified duration (search for similar items in EconPapers)
JEL-codes: C E F2 F3 G (search for similar items in EconPapers)
Date: 2023
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