Article2019

Over‐the‐Counter Market Frictions and Yield Spread Changes

113 citations0/0 files storedThe Journal of Finance

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Credit Risk and Financial Regulations Financial Markets and Investment Strategies Stochastic processes and financial applications

Abstract

ABSTRACT We empirically study whether systematic over‐the‐counter (OTC) market frictions drive the large unexplained common factor in yield spread changes. Using transaction data on U.S. corporate bonds, we find that marketwide inventory, search, and bargaining frictions explain 23.4% of the variation in the common component. Systematic OTC frictions thus substantially improve the explanatory power of yield spread changes and account for one‐third of their total explained variation. Search and bargaining frictions combined explain more in the common dynamics of yield spread changes than inventory frictions. Our findings support the implications of leading theories of intermediation frictions in OTC markets.

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1973The Pricing of Options and Corporate Liabilities 1974ON THE PRICING OF CORPORATE DEBT: THE RISK STRUCTURE OF INTEREST RATES*2002Illiquidity and stock returns: cross-section and time-series effects 2014A five-factor asset pricing model 2003Liquidity Risk and Expected Stock Returns 2008Market Liquidity and Funding Liquidity 1984A Simple Implicit Measure of the Effective Bid-Ask Spread in an Efficient Market 2001The Determinants of Credit Spread Changes

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