Liquidity Risk and the Cross-Section of Expected Corporate Bond Returns

In this study, the researchers will investigate whether market-wide liquidity is an important state variable for corporate bond pricing. The liquidity risk is determined by how corporate bond returns fluctuate with market-wide liquidity, instead of the risk of trading bonds when liquidity is low. The researchers will also test the effect of liquidity risk after controlling for systematic risks associated with default, term, and the Fama–French factors. They aim to show that term structure models of defaultable bonds should incorporate the liquidity factor to help explain the credit spread puzzle.