Liquidity Risk of Corporate Bond Returns

Viral V. Acharya, Yakov Amihud, Sreedhar T. Bharath

NBER Working Paper No. 16394
Issued in September 2010
NBER Program(s):   AP

We study the exposure of the U.S. corporate bond returns to liquidity shocks of stocks and treasury bonds over the period 1973 to 2007. A decline in liquidity of stocks or Treasury bonds produces conflicting effects: Prices of investment-grade bonds rise while prices of speculative grade bonds fall substantially. This effect is regime-switching in nature and holds when the state of the economy is in a "stress" regime. The likelihood of being in such a regime can be predicted by macroeconomic and financial market variables that are associated with adverse economic conditions. Our model can predict the out-of-sample bond returns for the stress years 2008-2009. These effects are robust to controlling for other systematic risks (term and default). Our findings suggest the existence of time-varying liquidity risk of corporate bond returns and episodes of flight to liquidity.

You may purchase this paper on-line in .pdf format from SSRN.com ($5) for electronic delivery.

Acknowledgments

Machine-readable bibliographic record - MARC, RIS, BibTeX