Quantifying Liquidity and Default Risks of Corporate Bonds over the Business Cycle, The Review of Financial Studies
We develop a structural credit model to examine how interactions between default and liquidity affect corporate bond pricing. The model features debt rollover and bond-price-dependent holding costs. Over the business cycle and in the cross-section, the model matches average default rates and credit spreads in the data, and captures variations in bid-ask and bond-CDS spreads. A structural decomposition reveals that default-liquidity interactions can account for 10%–24% of the level of credit spreads and 16%–46% of the changes in spreads over the business cycle. Further, liquidity-related corporate bond financing costs amount to 6% of the total issuance amount from 1996 to 2015.
Hui Chen, R. Cui, Konstantin Milbradt
Chen, Hui, R. Cui, and Konstantin Milbradt. 2018. Quantifying Liquidity and Default Risks of Corporate Bonds over the Business Cycle. The Review of Financial Studies. 31(3): 852-897.