TY  - JOUR
AU  - He,Zhiguo
AU  - Milbradt,Konstantin
TI  - Endogenous Liquidity and Defaultable Bonds
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 18408
PY  - 2012
Y2  - September 2012
UR  - http://www.nber.org/papers/w18408
L1  - http://www.nber.org/papers/w18408.pdf
N1  - Author contact info:
Zhiguo He
University of Chicago
Booth School of Business
5807 S. Woodlawn Avenue
Chicago, IL 60637
Tel: 773/834-3769
E-Mail: zhiguo.he@chicagobooth.edu

Konstantin Milbradt
MIT Sloan School of Management
100 Main Street, E62-633
Cambridge, MA 02142
Tel: 617/253-6240
Fax: 617/258-6855
E-Mail: milbradt@mit.edu
AB  - 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.
ER  -