Thesis on Jump and Volatility Risk and Extreme Illiquidity in the Corporate Bond Market


Student thesis: Doctoral Thesis

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Awarding Institution
  • Junbo WANG (Supervisor)
  • Zongrun WANG (External person) (External Supervisor)
Award date24 Aug 2022


This thesis studies the pricing of jump and volatility risk and extreme illiquidity in the cross-section of corporate bond returns, which are shown in two chapters.

In Chapter 1, we investigate the pricing of jump and volatility risk in the cross-section of corporate bonds and find that bonds with high jump and volatility betas have low expected returns. The jump and volatility risk effects are economically significant, exhibit an intra-rating pattern, and increase as ratings decrease. While both jump and volatility risk effects heighten during the subprime crisis period, jump risk becomes more important than volatility risk in times of stress. The pronounced negative jump and volatility risk premiums cannot be explained by coskewness, cokurtosis, or downside risk exposure and are robust to controlling for conventional risk factors and bond characteristics.

In Chapter 2, we show that corporate bonds carry a premium of extreme illiquidity (EIL). This premium permeates all rating categories and heightens in times of stress and periods with high uncertainty. EIL has predictive power in the cross-section for future returns up to at least a one-year horizon. Active investors like mutual funds prefer low EIL bonds that can be easily liquidated in bad times, 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 explanatory power, its effect is largely subsumed by bond-level EIL in a horserace regression.