Corporate Yield Spreads and Bond Liquidity

  • Author(s): LONG CHEN, DAVID A. LESMOND, JASON WEI
  • Published: Jan 11, 2007
  • Pages: 119-149
  • DOI: 10.1111/j.1540-6261.2007.01203.x

ABSTRACT

We find that liquidity is priced in corporate yield spreads. Using a battery of liquidity measures covering over 4,000 corporate bonds and spanning both investment grade and speculative categories, we find that more illiquid bonds earn higher yield spreads, and an improvement in liquidity causes a significant reduction in yield spreads. These results hold after controlling for common bond‐specific, firm‐specific, and macroeconomic variables, and are robust to issuers' fixed effect and potential endogeneity bias. Our findings justify the concern in the default risk literature that neither the level nor the dynamic of yield spreads can be fully explained by default risk determinants.

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