Liquidity Commonality in the Secondary Corporate Loan Market

This study is the first to identify a parsimonious measure of liquidity and examine liquidity commonality in the U.S. secondary corporate loan market. Using recently available liquidity data from Markit, we demonstrate that among a range of liquidity proxies, the bid-ask spread is the most effective liquidity measure and its variation across loans is strongly related to credit quality. Liquidity commonality shows an 18-fold increase during the 2007-09 global financial crisis over its pre-crisis level, implying substantial variation in liquidity risk across market states. A greater variation in loan market liquidity commonality relative to the equity market is consistent with the nature of the loan market, being a relatively illiquid over-the-counter market dominated by banks and diversified institutional investors. Liquidity commonality over the sample period is also found to be strongly influenced by funding liquidity.