TY - JOUR T1 - Valuation of Bond Illiquidity JF - The Journal of Fixed Income SP - 81 LP - 107 DO - 10.3905/jfi.2007.683320 VL - 16 IS - 4 AU - Christian Koziol AU - Peter Sauerbier Y1 - 2007/03/31 UR - https://pm-research.com/content/16/4/81.abstract N2 - 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 ER -