Working Paper: NBER ID: w25054
Authors: Efraim Benmelech; Nittai Bergman
Abstract: We analyze the empirical determinants of liquidity in debt markets in light of predictions stemming from debt-based information theories. We conduct a battery of tests confirming predictions of asymmetric information models of bond liquidity, including those that predict a``hockey-stick" relation between bond liquidity and underlying fundamental value. When debt is deep in the money, it becomes informationally insensitive and more liquid. In contrast, when firm value deteriorates towards the left tail, the value of debt becomes informationally sensitive and less liquid. We alleviate endogeneity concerns using exogenous variation in firm value that is plausibly not driven by bond liquidity. Our results shed new empirical light on the determination of liquidity in debt markets.
Keywords: Debt markets; Liquidity; Information asymmetries; Bond liquidity
JEL Codes: E44; E51; G01; G12; G14; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| declines in bond prices (G12) | increases in bond illiquidity (G12) |
| bond prices (G12) | bond illiquidity (G12) |
| higher credit ratings at issuance (G24) | greater illiquidity when downgraded (G33) |
| more equity analysts covering firms (G24) | more liquid bonds (G12) |
| higher equity volatility (G19) | increased bond illiquidity (G12) |
| bond maturity (G12) | liquidity (E41) |
| secured bonds (G12) | more liquid than unsecured bonds (G33) |
| sensitivity of bond illiquidity to bond price (G12) | number of analysts (G24) |
| bond price decreases (E43) | sensitivity of illiquidity increases for higher equity volatility (C58) |