Effects Of Idiosyncratic Volatility And Liquidity On Corporate Bond Spreads

As a major way of low-cost financing to listed companies, corporate bond attract more preference of institutional and individual investors for its relative lower risk and more stable income characteristics. Spread is one of the important attributes to corporate bonds, it provides basis for pricing of bonds and their derivatives, and also helps the investor and regulator to make right decisions, therefore, a research on factors that will influence corporate bond spreads has become increasingly important. There are various factors that will affect bond spread, and the major risks are liquidity risk, default risk, and market risk. In all, this paper finds that idiosyncratic volatility as a description of the value volatility of company’s assets can reflect the default probability of corporate debt, and liquidity indicators reflect the size of the liquidity risk of corporate bonds.This paper classify corporate bonds from three dimensions in industry, credit rating and maturity, based on Collin-Dufresne et al.(2001) model, we add the idiosyncratic volatility, liquidity and lagging indicators into it so as to study in-depth about the impact that two factors will have on yield changes on different corporate bonds.In this paper, the sample selected are corporate bonds that issued from 12 October, 2007 to 30 September 2014, from which most companies are from four industries, and they are raw materials, industry, finance and utilities totaled 326. We study the correlation level among sp reads, idiosyncratic volatility and liquidity, using the time series analysis from the company bond’s overall level to study the impact of idiosyncratic volatility and liquidity on industrial corporate bond spreads, and using panel data analysis from the c ompany bond’s individual level to study the influence of idiosyncratic volatility and liquidity on 8 groups corporate bond spreads.Empirical results show that the idiosyncratic volatility is significant positive correlated to corporate bond spreads, liqu idity from the dynamic and static angle are significant positive correlated to spreads. After adding lag indicators of idiosyncratic volatility and liquidity to the basic model, we found that lag indicators and spreads have a significant negative correlati on. When the relevant measure of liquidity and idiosyncratic volatility are controlled, the impact of various factors on the spread increased significantly, thus this paper confirmed that idiosyncratic risk and liquidity risk are important risk factors tha t affect corporate bond spreads. In addition, we also found that the macroeconomic situation and market risk have a positive impact on corporate bonds spread, but the risk of interest rate’s impact on corporate bond spreads is not clear. Company individual factors, the stock yields have a significant negative correlation to corporate bond spreads, a reasonable explanation is that when the company capital gains increase, the company’s probability of default will fall which will result lower credit spreads.