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STOCK LIQUIDITY AND CORPORATE BOND YIELD SPREADS: THEORY AND EVIDENCE
Author(s) -
Huang Henry H.,
Huang HungYi,
Oxman Jeffrey J.
Publication year - 2015
Publication title -
journal of financial research
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.319
H-Index - 49
eISSN - 1475-6803
pISSN - 0270-2592
DOI - 10.1111/jfir.12052
Subject(s) - market liquidity , corporate bond , bond , stock (firearms) , monetary economics , liquidity crisis , liquidity risk , financial system , business , financial economics , credit risk , stock market , economics , bond market , finance , mechanical engineering , paleontology , horse , biology , engineering
We examine the impact of individual stock liquidity on corporate bond yield spreads in the U.S. market. By extending the endogenous‐default model to include stock liquidity in the calculation of bond value we show that a drop in stock liquidity will increase the firm's credit risk by increasing the firm's default boundary, leading to an increase of the credit spread. Our model is consistent with the sharp increase in credit risk premiums and the “yield spread spike” phenomenon in corporate bond markets during the financial crisis. We present empirical evidence supportive of our model.