We investigate whether liquidity is an important price factor in the US corporate bond market. In particular, we focus on whether liquidity effects are more pronounced in periods of financial crises, ...especially for bonds with high credit risk, using a unique data set covering more than 20,000 bonds, between October 2004 and December 2008. We employ a wide range of liquidity measures and find that liquidity effects account for approximately 14% of the explained market-wide corporate yield spread changes. We conclude that the economic impact of the liquidity measures is significantly larger in periods of crisis, and for speculative grade bonds.
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.
We empirically study the role of dealers’ inventory risk in US corporate bond returns. To do so, we build a bond-level measure of exposure to inventory risk and find that the risk-adjusted return of ...a high-minus-low portfolio is 21 basis points per week. The inventory risk premium is amplified during times of crises, if hedging supply is low, as well as for bonds with higher credit risk. Our findings provide strong support for the asset pricing implication of inventory models and show that dealers use price pressure to compensate for bearing inventory risk.
We explore the link between a firm's stock returns and credit risk using a simple insight from structural models following Merton (1974): risk premia on equity and credit instruments are related ...because all claims on assets must earn the same compensation per unit of risk. Consistent with theory, we find that firms' stock returns increase with credit risk premia estimated from CDS spreads. Credit risk premia contain information not captured by physical or risk-neutral default probabilities alone. This sheds new light on the "distress puzzle"—the lack of a positive relation between equity returns and default probabilities—reported in previous studies.
Debt Refinancing and Equity Returns FRIEWALD, NILS; NAGLER, FLORIAN; WAGNER, CHRISTIAN
The Journal of finance (New York),
August 2022, Letnik:
77, Številka:
4
Journal Article
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ABSTRACT
This paper presents empirical evidence that the maturity structure of financial leverage affects the cross‐section of equity returns. We find that short‐term leverage is associated with a ...positive premium, whereas long‐term leverage is not. The premium for short‐term compared to long‐term leverage reflects higher exposure of equity to systematic risk. To rationalize our findings, we show that the same patterns emerge in a model of debt rollover risk with endogenous leverage and debt maturity choice. Our results suggest that analyses of leverage effects in asset prices and corporate financial applications should account for the maturity structure of debt.
We develop and empirically test a theory of optimal security design under adverse selection accounting for strategic trading by uninformed investors who will liquidate a security in secondary markets ...only if their idiosyncratic carrying costs exceed the security's expected trading loss. Such investors demand primary market discounts equaling expected carrying costs borne plus trading losses incurred. Issuers minimize the total illiquidity discount by splitting cash-flow into tranched debt claims with liquidity predicted to increase with seniority, while the optimal number of tranches increases with underlying cash-flow risk. Empirical tests confirm our model predictions.
We empirically study whether systematic over-the-counter (OTC) market frictions affect the large unexplained common factor in yield spread changes. Using transactions data on U.S. corporate bonds, we ...show that measures of marketwide inventory, search, and bargaining frictions reduce the unexplained common component by 19 percentage points. Systematic OTC frictions substantially improve the explanatory power of yield spread changes and account for one-third of their total explained variation. Inventory frictions are equally important in explaining the dynamics of yield spread changes as search and bargaining frictions combined. Our findings support the implications of leading theories of intermediation frictions in OTC markets.
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