Abstract
This paper investigates the effect of market and liquidity risks on corporate bond pricing in Turkey, an emerging market, and in Europe. Results show that corporate bond returns have exposure to liquidity factors and not to market factors in both settings. Corporate bonds issued in Turkey have significant exposure to fluctuations in benchmark treasury bond liquidity and corporate bond market liquidity; while corporate bonds issued in Eurozone have exposure to equity market liquidity and are sensitive to fluctuations in a 10-year generic government bond liquidity. The total estimated liquidity risk premium is 0.7% per annum for Turkish ?A? and above graded corporate bonds, and 1.08% for the last investment grade level (BBB-) long-term bonds. For Eurozone, the total liquidity risk premium is 0.27% for investment grade 5-10 year term bonds, 1.05% for high-yield 1-5 year term bonds and 1.02% for high-yield 5-10 year term category.
Highlights
Excess corporate bond returns are not associated with the market risk factors including change in USD/TRY exchange rate (M1), Borsa Istanbul 100 Index (BIST100) index return (M2), and Turkey Sovereign 10-Year CDS return (M3)
The aim of this study is to investigate the role of liquidity risk and market risk in explaining corporate bond returns in an emerging market, Turkey, and compare the findings using data from the Eurozone
Market risk and liquidity risk are considered together because returns on corporate bonds are open to shocks both on government bond market and equity market (Kwan, 1996)
Summary
Earlier studies on corporate bond markets mostly focused on the default component of credit spreads assuming that non-default components for bonds of different classes are the same (Hui Chen et al, 2017). This effect was most pronounced for firms with lower default risk In another non-US study, Kiyotaka Nakashima and Makoto Saito (2009) explored the determinants of the credit spread of corporate bond rates over interest swap rates by using secondary market data on corporate bonds issued in Japan between 1997 and 2005. They found that credit spreads correctly reflected firm level financial factors debt-to-equity ratios, volatility, and maturity, especially for longer-term bonds. As is clear from the above discussion, only a limited number of studies focused on corporate bond returns in emerging markets and none has investigated the impact of liquidity risk and market risk on corporate bond spreads in Turkey, a gap which we are trying to fill
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