European corporate bond liquidity and yield spreads

Abstract

PURPOSE OF THE STUDY The purpose of this study is to provide new empirical evidence on European corporate bond liquidity determinants and the liquidity effect on yield spreads. European corporate bond market is mostly ignored in corporate bond liquidity literature and this thesis’ purpose is to contribute to literature by being among the first papers to estimate liquidity determinants with comprehensive European corporate bond data, covering both investment grade and speculative grade rating categories.

DATA The corporate bond data is from years 2005 – 2009 covering all credit ratings. Corporate bond pricing, rating, and descriptive data is obtained from Bank of America Merrill Lynch. The sample consists of euro denominated corporate bonds with the amount outstanding more than 250 million euros for investment grade bonds and 100 million for speculative grade bonds. The total number of unique bonds is 2589 bonds, with the total number of bond-years amounting to 7073. Bond bid and ask quotations, company level information, and macroeconomic data is obtained from Bloomberg.

RESULTS The results indicate liquidity to be priced in the corporate bond yield spreads. Liquidity measures bid-ask spread and percentage of zero return days are capturing the liquidity effect for investment grade bonds effectively. For speculative grade bonds, liquidity measures are capturing liquidity with the pre-crisis sample-period effectively. Liquidity proxy portfolio analysis shows liquidity premiums to be time-varying and dependent on credit market conditions.