Date of Award


Degree Type


Degree Name

Doctor of Philosophy in Business Administration




Interdepartmental Program

First Advisor

Michael A. Goldstein

Second Advisor

Shaw K. Chen


The objective of this research is to study the relationship between various aspects of corporate bonds liquidity , transaction costs and trading activity, and their perceived credit quality as measured by credit ratings. For debt securities, Credit quality and liquidity are perhaps the most important factors that affect the investors’ decisions whether to trade or hold these assets on their portfolio, as several theoretical and empirical studies identify these factors as key components of bonds yield spreads. However, the interaction and relationship between these two characteristics is not sufficiently addressed in the literature. From the investors’ perspective, it is beneficial to know whether they face a tradeoff between credit quality and liquidity or if both desirable features move in the same direction. We use more than twelve years of Enhanced TRACE data from 2002 to 2014 to analyze the liquidity of corporate bonds both cross-sectionally across credit ratings and intertemporally around credit rating changes.

The first manuscript studies the relationship between corporate bonds’ credit risk and their market liquidity, and the dynamics of this relationship over the period from 2002 to 2014. Unlike the implication of theoretical models, our findings do not empirically support a monotonically positive relation between credit risk and transaction costs. Instead, we find an inverted U-shaped relationship where bonds with ratings near the Investment grade/ High yield boundary have the largest transaction costs (lowest liquidity) after controlling for other relevant factors. One explanation for this finding is that bond dealers behave more as brokers in speculative grade bonds and are reluctant to enter overnight positions in these risky securities, unless they find the other side of the trade. This kind of dealers behavior potentially reduces the transaction costs of lower rated bond, as captured by bid-ask spreads, to only reflect the cost of searching for counterparty rather than inventory or adverse selection risks, and may be even more pronounced during distressed market conditions due to more capital constrains and less funding liquidity. Consistent with this explanation, using a Markov Switching time series model, we find that while bid-ask spreads significantly increase for investment grade bonds during the crisis, they stay invariant for junk bonds.

The second essay expands this investigation to examine the impact of rating changes on corporate bonds’ liquidity around the rating change announcements using an event study methodology. Many institutional investors such as insurance companies or pension funds are prohibited by regulations from investing substantial portion of their portfolios in risky bonds. Hence, the rating changes that move the bonds out of the investment grade category can elicit selling pressure or even fire sale of the fallen angels. Beyond just the investment grade issue, prudential regulators also have scoring algorithms that require more capital to be held as ratings fall. Our findings suggest an abnormal decrease in liquidity following the rating downgrades with more severe impact for downgrades that move the bond from investment grade to high yield category. Consistent with the prior findings, investment grade bonds liquidity is more sensitive to rating downgrades and for bonds that are already risky, further downgrades doesn’t seem to affect their liquidity and transaction costs significantly. We also find that bond and issuer characteristics like issue size and industry group affect the liquidity conditions around rating events.

The third essay reviews the theoretical as well as empirical literature on the impact of liquidity on corporate bonds prices and yield spreads.



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