STOCK LIQUIDITY AND CORPORATE BOND YIELD SPREADS: THEORY AND EVIDENCE

Henry Hongren Huang · Hung‐Yi Huang · Jeffrey J. Oxman

42 citations0/0 files storedThe Journal of Financial Research

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Credit Risk and Financial Regulations Corporate Finance and Governance Stochastic processes and financial applications

Abstract

Abstract We examine the impact of individual stock liquidity on corporate bond yield spreads in the U.S. market. By extending the endogenous‐default model to include stock liquidity in the calculation of bond value we show that a drop in stock liquidity will increase the firm's credit risk by increasing the firm's default boundary, leading to an increase of the credit spread. Our model is consistent with the sharp increase in credit risk premiums and the “yield spread spike” phenomenon in corporate bond markets during the financial crisis. We present empirical evidence supportive of our model.

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References

1993Common risk factors in the returns on stocks and bonds 1997On Persistence in Mutual Fund Performance 1974ON THE PRICING OF CORPORATE DEBT: THE RISK STRUCTURE OF INTEREST RATES*2002Illiquidity and stock returns: cross-section and time-series effects 2003Liquidity Risk and Expected Stock Returns 1986Asset pricing and the bid-ask spread 1977DEBT AND TAXES*2005Asset pricing with liquidity risk

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