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The pricing of different dimensions of liquidity: Evidence from government guaranteed bank bonds

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  • Black, Jeffrey R.
  • Stock, Duane
  • Yadav, Pradeep K.
Abstract
Seminal market microstructure literature identifies at least three important dimensions of liquidity: trading costs, depth, and resiliency. We investigate the relevance of each of these three dimensions of liquidity - separately and in conjunction - for the pricing of corporate bonds. Unlike previous studies, our sample allows us to cleanly separate the default and non-default components of yield spreads. We find that each of the above three dimensions of liquidity impact non-default spreads, with trading costs and resiliency being more important than depth. We also find that both bond-specific and market-wide dimensions of liquidity are priced in non-default spreads. Finally, we find that, even though these three dimensions of liquidity account for virtually the entire non-default spread, there does exist in some periods a small residual non-default yield spread that is consistent with an additional "flight-to-extreme-liquidity" premium reflecting investor preference for assets that enable quickest possible disengagement from the market when necessary.

Suggested Citation

  • Black, Jeffrey R. & Stock, Duane & Yadav, Pradeep K., 2015. "The pricing of different dimensions of liquidity: Evidence from government guaranteed bank bonds," CFR Working Papers 15-10, University of Cologne, Centre for Financial Research (CFR).
    • Handle: RePEc:zbw:cfrwps:1510
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    References listed on IDEAS

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    1. Brennan, Michael J. & Subrahmanyam, Avanidhar, 1996. "Market microstructure and asset pricing: On the compensation for illiquidity in stock returns," Journal of Financial Economics, Elsevier, vol. 41(3), pages 441-464, July.
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    3. Chordia, Tarun & Roll, Richard & Subrahmanyam, Avanidhar, 2000. "Commonality in liquidity," Journal of Financial Economics, Elsevier, vol. 56(1), pages 3-28, April.
    4. Friewald, Nils & Jankowitsch, Rainer & Subrahmanyam, Marti G., 2012. "Illiquidity or credit deterioration: A study of liquidity in the US corporate bond market during financial crises," Journal of Financial Economics, Elsevier, vol. 105(1), pages 18-36.
    5. Lin, Hai & Wang, Junbo & Wu, Chunchi, 2011. "Liquidity risk and expected corporate bond returns," Journal of Financial Economics, Elsevier, vol. 99(3), pages 628-650, March.
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