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Flight from Liquidity and Corporate Bond Yields

Author

Listed:
  • Ali Ebrahim Nejad
  • Saeid Hoseinzade
  • Aryan Molanaei

Abstract

This paper documents that in distress periods, liquidity constrained investors sell liquid corporate bonds and hold onto illiquid ones, a phenomenon which we refer to as flight from liquidity. Performing within issuer‐time analysis to properly control for credit risk, we find that flight from liquidity results in a decline in the liquidity premium. In other words, liquid bonds that are significantly more expensive in normal market conditions, lose more value in distress periods and trade at a closer, and sometimes at an indistinguishable, yield spread to their illiquid peers from the same issuer. We also find that these shocks to the liquidity premium are short‐lived and do not have a long‐lasting pricing impact. We provide suggestive evidence that the liquidity clientele effect derives these results. Our findings suggest that investment exposure to liquid bonds entails a unique risk arising during periods of distress.

Suggested Citation

  • Ali Ebrahim Nejad & Saeid Hoseinzade & Aryan Molanaei, 2023. "Flight from Liquidity and Corporate Bond Yields," Financial Markets, Institutions & Instruments, John Wiley & Sons, vol. 32(5), pages 255-283, December.
    • Handle: RePEc:wly:finmar:v:32:y:2023:i:5:p:255-283
    DOI: 10.1111/fmii.12182
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    References listed on IDEAS

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