An Affine Model of Corporate Bond Spreads with Liquidity

1
An Affine Model of Corporate Bond Spreads with
Liquidity

• Project Outline
• Nick Xuhui Pan
• January 23, 2008

2
Main Issue

• Empirical works documented significant risk
  premia of liquidity effects in US corporate bonds
  market and liquidity is an important determinant
  of bond spreads (e.g. Driessen (2005), RFS,
  Longstaff, Mithal and Neis (2005),JF, Covitz and
  Downing (2007),JF, Chen, Lesmond and Wei (2007) ,
  JF).
• Liquidity spreads are not well modeled so far,
  neither by structural model, nor by reduced-form
  model. Traditional literatures tended to use
  credit spreads and bond spreads interchangeably,
  while indeed credit spreads are only one
  component of bond spreads.

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Brief Literature Review

• Structural model
• Ericsson and Renault (2006), JF.
• Reduced form model
• Duffie and Singleton (1999), RFS, Duffie,
  Pedersen and Singleton (2003) , JF, Longstaff,
  Mithal and Neis (2005) , JF.

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Idea

• My study is mostly related to Liu, Longstaff
  and Mandell (2006, JB) and Jacobs and Li (2007,
  MS).
• The main purpose of this study is to
  simultaneously model the default risk and
  liquidity risk components of corporate bond
  spreads while considering the stochastic
  volatility of default risk (and liquidity risk).

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Data

• US Treasury bill
• Monthly data, CRSP
• Corporate bond prices (non-callable,
  non-convertible)
• Fixed Income Securities Database ( or known as
  Lehman Brothers Fixed Income Database) and CRSP
• Credit Default Swap (CDS) premia
• CreditTrade Market Prices Database (shorter
  period than bonds and T-bill, different samples)