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Effects of Liquidity on the Nondefault Component of Corporate Yield Spreads: Evidence from Intraday Transactions Data

Author

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  • Song Han

    (Federal Reserve Board and Hong Kong Institute for Monetary Research)

  • Hao Zhou

    (Federal Reserve Board)

Abstract
We estimate the nondefault component of corporate bond yield spreads and examine its relationship with bond liquidity. We measure bond liquidity using intraday transactions data and estimate the default component using the term structure of credit default swaps (CDS) spreads. With swap rate as the risk free rate, the estimated nondefault component is generally moderate but statistically significant for AA-, A-, and BBB-rated bonds and increasing in this order. With Treasury rate as the risk free rate, the estimated nondefault component is the largest in basis points for BBB-rated bonds but, as a fraction of yield spreads, it is the largest for AAA-rated bonds. Controlling for the unobservable firm heterogeneity, we find a positive and significant relationship between the nondefault component and illiquidity for investment-grade bonds but no significant relationship for speculative-grade bonds. We also find that the nondefault component comoves with indicators for macroeconomic conditions.

Suggested Citation

  • Song Han & Hao Zhou, 2011. "Effects of Liquidity on the Nondefault Component of Corporate Yield Spreads: Evidence from Intraday Transactions Data," Working Papers 022011, Hong Kong Institute for Monetary Research.
    • Handle: RePEc:hkm:wpaper:022011
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    More about this item

    Keywords

    Corporate Bond Yield Spreads; Credit Default Swaps; Liquidity; CDS-Bond Basis;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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