PT  - JOURNAL ARTICLE
AU  - Christian Koziol
AU  - Peter Sauerbier
TI  - Valuation of Bond Illiquidity
AID  - 10.3905/jfi.2007.683320
DP  - 2007 Mar 31
TA  - The Journal of Fixed Income
PG  - 81--107
VI  - 16
IP  - 4
4099  - https://pm-research.com/content/16/4/81.short
4100  - https://pm-research.com/content/16/4/81.full
AB  - In this article, the authors present an easily applicable option-theoretical approach to quantifying liquidity spreads of bonds. Following Longsta [1995], they describe the value of liquidity as that of exotic options. After valuing these lookback options in a framework with interest rate uncertainty, this approach yields liquidity spreads for bonds that cannot be traded continuously. The liquidity spreads show plausible properties: they are humped-shaped functions of the maturity and increase with the interest rate volatility. Liquidity spreads depend on the distribution of possible trading dates but are independent of the short rate. Regarding German Jumbo Pfandbrief market data, they find several parallels between theoretical and empirical liquidity spreads, while credit risk has nearly no explanatory power.TOPICS: Legal and regulatory issues for structured finance, options, statistical methods