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Liquidity of Corporate Bonds Jack Bao, Jun Pan and Jiang Wang¤

After drilling the well, the operator may perform interim reclamation—the practice of reclaiming surfaces that were disturbed to prepare a well for drilling but that are no longer needed. For example, operators may need a 10-acre drill pad to safely drill a series of wells. However, once the wells are drilled, operators may only need 4 acres to safely service the wells over their lifetime. In this case, the operator could reseed and regrade the 6 acres of the initial pad that are no longer needed. While BLM does not generally require interim reclamation in all permits it issues, it. | Liquidity of Corporate Bonds Jack Bao Jun Pan and Jiang Wang This draft March 22 2008 Abstract This paper examines the liquidity of corporate bonds. Using transaction-level data for a broad cross-section of corporate bonds from 2003 through 2007 we construct a measure of illiquidity by estimating the magnitude of price reversals in corporate bonds. We find the illiquidity in corporate bonds to be significant and substantially more severe than what can be explained by bid-ask bounce. We establish a robust connection between our illiquidity measure and liquidity-related bond characteristics. In particular it is higher for older and smaller bonds and bonds with smaller average trade sizes and higher idiosyncratic return volatility. Aggregating our illiquidity measure across bonds we find strong commonality in the time variation of bond illiquidity which rises sharply during market crises and reaches an all-time high during the recent sub-prime mortgage crisis. Moreover monthly changes in aggregate illiquidity are strongly related to changes in the CBOE VIX Index. We also find a robust positive relation between our illiquidity measure and bond yield spreads that is economically significant. Bao is from MIT Sloan School of Management jackbao@mit.edu Pan is from MIT Sloan School of Management and NBER junpan@mit.edu and Wang is from MIT Sloan School of Management CCFR and NBER wangj@mit.edu . Support from the outreach program of J.P. Morgan is gratefully acknowledged. 1 Introduction The liquidity of the corporate bond market has been of interest for researchers practitioners and policy makers. Many studies have attributed deviations in corporate bond prices from their theoretical values to the influence of illiquidity in the market.1 Yet our understanding of how to quantify illiquidity remains limited. And without a credible measure of illiquidity it is difficult to have a direct and serious examination of the asset-pricing influence of illiquidity and its implications .