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Asian Review of Financial Research, Vol., No..
pp.75~132
pp.75~132
The More Illiquid, The More Expensive : the Reversed Liquidity Premium in Corporate Bonds
Jaewon Choi University of Illinois Urbana-Champaign, Department of Finance
Jungsuk Han Seoul National University, Department of Finance
Sean S. Shin Aalto University, Department of Finance
Ji Hee Yoon University College London, Department of Economics and School of Management
We show that illiquid bonds can become more expensive than liquid bonds with almost identical cash flows during market distress times. The economic mechanism behind the results is search frictions. When the search friction is high, marginal traders prefer to sell liquid bonds at lower prices than illiquid bonds because failure to find buyers can be costly. We empirically identify the reversed liquidity premium through within-issuer-date matching of bonds and the regression discontinuity design based on newly issued corporate bonds. In both the identification settings, we find that the yield differentials between illiquid and liquid bonds become negative during the market distress times. Using insurance company trades, we document transactionlevel evidence for the reversed liquidity premium for same-issuer bonds on the same day that are traded by the same insurer.
Jaewon Choi
Jungsuk Han
Sean S. Shin
Ji Hee Yoon
We show that illiquid bonds can become more expensive than liquid bonds with almost identical cash flows during market distress times. The economic mechanism behind the results is search frictions. When the search friction is high, marginal traders prefer to sell liquid bonds at lower prices than illiquid bonds because failure to find buyers can be costly. We empirically identify the reversed liquidity premium through within-issuer-date matching of bonds and the regression discontinuity design based on newly issued corporate bonds. In both the identification settings, we find that the yield differentials between illiquid and liquid bonds become negative during the market distress times. Using insurance company trades, we document transactionlevel evidence for the reversed liquidity premium for same-issuer bonds on the same day that are traded by the same insurer.
OTC market,Liquidity,Flight-from-liquidity,Limits-to-arbitrage,Price pressure,Fire sale