RT Journal Article
SR Electronic
T1 Valuation of Bond Illiquidity
JF The Journal of Fixed Income
FD Institutional Investor Journals
SP 81
OP 107
DO 10.3905/jfi.2007.683320
VO 16
IS 4
A1 Christian Koziol
A1 Peter Sauerbier
YR 2007
UL https://pm-research.com/content/16/4/81.abstract
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