A risk not worth taking - The corporate bond liquidity factor

Abstract

This study documents properties of market-wide corporate bond liquidity and tests if liquidity risk is priced. In market downturns, when many investors want to liquidate corporate bonds, transaction costs rise for sellers and fall for buyers. The negative relation between buyer and seller liquidity motivates a new across-measure liquidity factor that incorporates an asymmetric liquidity component. Aggregate liquidity measures are persistent, driven by common systematic components, and predict returns. Shocks to market liquidity drive return variation in the time series. However, this risk exposure is not priced as corporate bonds do not earn a positive cross-sectional liquidity risk premium.