@techreport{NBERw18408,
 title = "Endogenous Liquidity and Defaultable Bonds",
 author = "Zhiguo He and Konstantin Milbradt",
 institution = "National Bureau of Economic Research",
 type = "Working Paper",
 series = "Working Paper Series",
 number = "18408",
 year = "2012",
 month = "September",
 URL = "http://www.nber.org/papers/w18408",
 abstract = {This paper studies the interaction between fundamental and liquidity for defaultable corporate bonds that are traded in an over-the-counter secondary market with search frictions. Bargaining with dealers determines a bond's endogenous liquidity, which depends on both the firm fundamental and the time-to-maturity of the bond. Corporate default decisions interact with the endogenous secondary market liquidity via the rollover channel. A default-liquidity loop arises: Earlier endogenous default worsens a bond's secondary market liquidity, which amplifies equity holders' rollover losses, which in turn leads to earlier endogenous default. Besides characterizing in closed form the full inter-dependence between liquidity premium and default premium for credit spreads, we also study the optimal maturity implied by the model based on the tradeoff between liquidity provision and inefficient default.},
}