A Global Liquidity Factor for Fixed Income Pricing

Liquidity premiums have been widely documented for equity and bond markets. However, there is a lack of easily implementable measures of systematic liquidity for bond markets, which are typically far less liquid. We show that a simple liquidity factor - based on the difference between corporate bond spreads and credit default swaps - is signifcantly associated with returns in a wide range of fixed income markets. The corresponding liquidity premium is time-varying but persistent and drives a fair amount of serial and cross-sectional variation in fixed income prices. Moreover, liquidity exposure varies predictably with maturity and credit rating suggesting a ight-to-quality phenomenon.