Abstract
This paper examines the liquidity of corporate bonds. Using transaction-level data for a broad cross-section of corporate bonds from 2003 through 2007, we construct a measure of illiquidity by estimating the magnitude of price reversals in corporate bonds. We flnd the illiquidity in corporate bonds to be signiflcant and substantially more severe than what can be explained by bid-ask bounce. We establish a robust connection between our illiquidity measure and liquidity-related bond characteristics. In particular, it is higher for older and smaller bonds and bonds with smaller average trade sizes and higher idiosyncratic return volatility. Aggregating our illiquidity measure across bonds, we flnd strong commonality in the time variation of bond illiquidity, which rises sharply during market crises and reaches an all-time high during the recent sub-prime mortgage crisis. Moreover, monthly changes in aggregate illiquidity are strongly related to changes in the CBOE VIX Index. We also flnd a robust positive relation between our illiquidity measure and bond yield spreads that is economically signiflcant.
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