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Recent research has shown that default risk accounts for only a part of the total yield spread on risky corporate bonds relative to their risk-less benchmarks. One candidate for the unexplained portion of the spread is a premium for liquidity. The authors investigate this possibility by relating the liquidity of corporate bonds to the basis between the Credit Default Swap (CDS) price of the issuer and the par equivalent corporate bond yield spread. The liquidity of a bond is measured using a recently developed measure called latent liquidity, which is defined as the weighted average turnover of funds holding the bond, where the weights are their fractional holdings of the bond.
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