Extreme Illiquidity and Cross-Sectional Corporate Bond Returns

Xi Chen; Junbo Wang; Chunchi Wu; Di Wu

doi:10.1016/j.finmar.2024.100895

Extreme Illiquidity and Cross-Sectional Corporate Bond Returns

Xi Chen, Junbo Wang^*, Chunchi Wu, Di Wu

^*Corresponding author for this work

Department of Economics and Finance

Research output: Journal Publications and Reviews › RGC 21 - Publication in refereed journal › peer-review

4 Citations (Scopus)

Abstract

Corporate bonds carry an extreme illiquidity (EIL) premium. This premium permeates all rating categories and heightens during financial crises and periods of high uncertainty. EIL has predictive power in the cross-section for future returns up to at least one year. Active investors like mutual funds prefer low EIL bonds that can be easily liquidated during times of stress, whereas passive institutional investors overweight high EIL bonds to receive the EIL premium. While adding an EIL factor constructed from portfolios to the factor model increases the explanatory power, its effect is largely subsumed by bond-level EIL in a horse race.

© 2024 Elsevier B.V. All rights reserved.

Original language	English
Article number	100895
Journal	Journal of Financial Markets
Volume	68
Online published	16 Feb 2024
DOIs	https://doi.org/10.1016/j.finmar.2024.100895
Publication status	Published - Mar 2024

Funding

We thank Yakov Amihud, Dániel Havran (discussant at 13th Annual Financial Market Liquidity Conference), and Alexander Valentin (discussant at 8th Paris Financial Management Conference) for many useful comments and suggestions. Junbo Wang acknowledges financial support from a City University Strategic Research Grant (Projects 7005775 and 7005955), and a RGC Research Infrastructure Grant (Project 9042839). Di Wu acknowledges financial support from RGC Early Career Scheme (Project 9048192).

Research Keywords

Extreme illiquidity
Corporate bond pricing
Ratings
Financial crisis
Tail risk

RGC Funding Information

RGC-funded

UN SDGs

This output contributes to the following UN Sustainable Development Goals (SDGs)

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title = "Extreme Illiquidity and Cross-Sectional Corporate Bond Returns",

abstract = "Corporate bonds carry an extreme illiquidity (EIL) premium. This premium permeates all rating categories and heightens during financial crises and periods of high uncertainty. EIL has predictive power in the cross-section for future returns up to at least one year. Active investors like mutual funds prefer low EIL bonds that can be easily liquidated during times of stress, whereas passive institutional investors overweight high EIL bonds to receive the EIL premium. While adding an EIL factor constructed from portfolios to the factor model increases the explanatory power, its effect is largely subsumed by bond-level EIL in a horse race.{\textcopyright} 2024 Elsevier B.V. All rights reserved.",

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author = "Xi Chen and Junbo Wang and Chunchi Wu and Di Wu",

year = "2024",

month = mar,

doi = "10.1016/j.finmar.2024.100895",

language = "English",

volume = "68",

journal = "Journal of Financial Markets",

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T1 - Extreme Illiquidity and Cross-Sectional Corporate Bond Returns

AU - Chen, Xi

AU - Wang, Junbo

AU - Wu, Chunchi

AU - Wu, Di

PY - 2024/3

Y1 - 2024/3

N2 - Corporate bonds carry an extreme illiquidity (EIL) premium. This premium permeates all rating categories and heightens during financial crises and periods of high uncertainty. EIL has predictive power in the cross-section for future returns up to at least one year. Active investors like mutual funds prefer low EIL bonds that can be easily liquidated during times of stress, whereas passive institutional investors overweight high EIL bonds to receive the EIL premium. While adding an EIL factor constructed from portfolios to the factor model increases the explanatory power, its effect is largely subsumed by bond-level EIL in a horse race.© 2024 Elsevier B.V. All rights reserved.

AB - Corporate bonds carry an extreme illiquidity (EIL) premium. This premium permeates all rating categories and heightens during financial crises and periods of high uncertainty. EIL has predictive power in the cross-section for future returns up to at least one year. Active investors like mutual funds prefer low EIL bonds that can be easily liquidated during times of stress, whereas passive institutional investors overweight high EIL bonds to receive the EIL premium. While adding an EIL factor constructed from portfolios to the factor model increases the explanatory power, its effect is largely subsumed by bond-level EIL in a horse race.© 2024 Elsevier B.V. All rights reserved.

KW - Extreme illiquidity

KW - Corporate bond pricing

KW - Ratings

KW - Financial crisis

KW - Tail risk

UR - http://www.scopus.com/inward/record.url?scp=85186070430&partnerID=8YFLogxK

UR - https://www.scopus.com/record/pubmetrics.uri?eid=2-s2.0-85186070430&origin=recordpage

U2 - 10.1016/j.finmar.2024.100895

DO - 10.1016/j.finmar.2024.100895

M3 - RGC 21 - Publication in refereed journal

SN - 1386-4181

VL - 68

JO - Journal of Financial Markets

JF - Journal of Financial Markets

M1 - 100895

ER -

Extreme Illiquidity and Cross-Sectional Corporate Bond Returns

Abstract

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Research Keywords

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ECS: Can Time-Varying Recovery of Rare Disasters Explain Equity Term Structure?

GRF: Valuation and Sensitives of Callable Debt

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