Liquidity risk of corporate bond returns

Conditional approach

Viral V. Acharya, Yakov Amihud, Sreedhar Bharath

Research output: Contribution to journalArticle

61 Citations (Scopus)

Abstract

We study the exposure of the US corporate bond returns to liquidity shocks of stocks and Treasury bonds over the period 1973-2007 in a regime-switching model. In one regime, liquidity shocks have mostly insignificant effects on bond prices, whereas in another regime, a rise in illiquidity produces significant but conflicting effects: Prices of investment-grade bonds rise while prices of speculative-grade (junk) bonds fall substantially (relative to the market). Relating the probability of these regimes to macroeconomic conditions we find that the second regime can be predicted by economic conditions that are characterized as "stress." These effects, which are robust to controlling for other systematic risks (term and default), suggest the existence of time-varying liquidity risk of corporate bond returns conditional on episodes of flight to liquidity. Our model can predict the out-of-sample bond returns for the stress years 2008-2009. We find a similar pattern for stocks classified by high or low book-to-market ratio, where again, liquidity shocks play a special role in periods characterized by adverse economic conditions.

Original languageEnglish (US)
Pages (from-to)358-386
Number of pages29
JournalJournal of Financial Economics
Volume110
Issue number2
DOIs
StatePublished - Nov 2013

Fingerprint

Liquidity risk
Bond returns
Corporate bonds
Liquidity shocks
Economic conditions
Liquidity
Macroeconomic conditions
Time-varying
Treasury bonds
Regime-switching model
Systematic risk
Bond prices
Book-to-market ratio
Junk bonds
Price effects
Illiquidity

Keywords

  • Credit spreads
  • Default
  • Flight to liquidity
  • Liquidity risk
  • Recession

ASJC Scopus subject areas

  • Accounting
  • Strategy and Management
  • Economics and Econometrics
  • Finance

Cite this

Liquidity risk of corporate bond returns : Conditional approach. / Acharya, Viral V.; Amihud, Yakov; Bharath, Sreedhar.

In: Journal of Financial Economics, Vol. 110, No. 2, 11.2013, p. 358-386.

Research output: Contribution to journalArticle

Acharya, Viral V. ; Amihud, Yakov ; Bharath, Sreedhar. / Liquidity risk of corporate bond returns : Conditional approach. In: Journal of Financial Economics. 2013 ; Vol. 110, No. 2. pp. 358-386.
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