Working Paper: NBER ID: w16394
Authors: Viral V. Acharya; Yakov Amihud; Sreedhar T. Bharath
Abstract: We study the exposure of the US corporate bond returns to liquidity shocks of stocks and Treasury bonds over the period 1973 - 2007 in a regime - switching model. In one regime, liquidity shocks have mostly insignificant effects on bond prices, whereas in another regime, a rise in illiquidity produces significant but conflicting effects: Prices of investment-grade bonds rise while prices of speculative-grade (junk) bonds fall substantially (relative to the market). Relating the probability of these regimes to macroeconomic conditions we find that the second regime can be predicted by economic conditions that are characterized as "stress." These effects, which are robust to controlling for other systematic risks (term and default), suggest the existence of time-varying liquidity risk of corporate bond returns conditional on episodes of flight to liquidity. Our model can predict the out-of-sample bond returns for the stress years 2008 - 2009. We find a similar pattern for stocks classified by high or low book-to-market ratio, where again, liquidity shocks play a special role in periods characterized by adverse economic conditions.
Keywords: Liquidity Risk; Corporate Bonds; Regime-Switching Model
JEL Codes: G12; G13; G32; G33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Liquidity shocks (E44) | Bond prices (G12) |
| Positive liquidity shock (E41) | Investment-grade bond prices (G12) |
| Positive liquidity shock (E41) | Speculative-grade junk bond prices (G19) |
| Economic distress (H84) | Liquidity betas for junk bonds (G33) |
| Economic distress (H84) | Liquidity betas for investment-grade bonds (G12) |
| Macroeconomic conditions (E66) | Regime identification (P26) |