The Importance of Investor Heterogeneity: An Examination of the Corporate Bond Market - Jane Li

Finance

Speaker : Jane Li (Columbia)

We show secondary market frictions now have larger effects on credit spreads than in 2005. We provide a model connecting this to the rapid growing mutual fund shares in the corporate bond market. The model features investors with different trading needs, choosing among a risk-free asset and heterogeneous illiquid bonds. As the risk-free rate declines, short-term investors enter the bond market, reaching for yields. Although they provide liquidity, their greater trading needs amplify the sensitivity of credit yields to bid-ask spreads, leading to larger liquidity components. We test the model’s predictions using U.S. investor holdings data and find consistent evidence.

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