The Illiquidity of Corporate Bonds

This paper examines the illiquidity of corporate bonds and its asset-pricing implications. Using transactions data from 2003 to 2009, we show that the illiquidity in corporate bonds is substantial, significantly greater than what can be explained by bid-ask spreads. We establish a strong link between bond illiquidity and bond prices. In aggregate, changes in market-level illiquidity explain a substantial part of the time variation in yield spreads of high-rated (AAA through A) bonds, overshadowing the credit risk component. In the cross-section, the bond-level illiquidity measure explains individual bond yield spreads with large economic significance.