The Pricing and Performance of New Corporate Bonds: Sorting Out Underpricing and Liquidity Effects

Abstract

Recent developments in the U.S. corporate bond market, as well as recent evidence on the pricing of illiquidity in this market, prompt us to reexamine the pricing of new bonds. The pricing of new investment-grade bonds appears to reflect both initial underpricing and higher liquidity: New bonds generally have lower yields than seasoned benchmarks, and average benchmark-adjusted returns form a humped pattern by horizon. We then test whether liquidity effects in bonds are linked to issuers’ equity liquidity. Generally, we find that equity and bond illiquidity are linked at the firm level, and that equity illiquidity is priced in bonds. For new bonds, equity liquidity is generally higher for new-bond issuers than for firms with benchmark seasoned bonds, and equity liquidity explains liquidity effects in both the pricing and performance of new bonds.