bond yield – liquidity premium ^ credit spread

I guess an issuer A’s bond may trade at a Higher yield than an issuer B’s bond, even if A’s credit quality is higher. Paradox?

One reason i can imagine is liquidity preference. Suppose you are an investor. Suppose the 2 bonds have the same coupon and other features. You as well as the market know that bond A is (slightly) less likely to default than B, but you may still be willing to pay a bit more for B, because it’s easier to sell it when you need cash.

Bond A may be an unknown entity, traded on very few markets (including bank’s private distribution networks), so there are far fewer bids of A then B. The lower market access leads to lower buyer competition, lower bid prices when you are forced to sell. 
Therefore, a prudent investor may be willing to pay more for bond B.
Since many investors behave similarly, B gets higher buyer competition, higher valuation and lower yield (spread).

Similarly, McDonald burgers may be smaller but more expensive than the no-name burger next door — liquidity

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s