(In)Frequently traded corporate bonds and pricing implications of liquidity dry-ups

Abstract

I study the link between corporate bond trading activity and expected bond return. I show that many individual corporate bonds experience booms and busts of trading activity. Such (in)frequently traded bonds have higher expected returns following periods of active trading, alongside greater return volatility. Of two actively traded bonds, one with a history of trading activity dry-ups carries the expected return premium of 10-20 bps per month, controlling for bond credit risk and illiquidity characteristics. Therefore, it is not just the current state of illiquidity that impacts expected return but also the bond’s recent history of illiquidity fluctuations. I connect liquidity dry-ups with changes in bond institutional ownership, implying that the expected return and risk also depend on who owns the bonds.