anshultongia

Thanks for the answers so far guys, but...

How about this,

A comparison of yields on a risk free liquid bond with an equivalent position in corporate bonds protected against default risk using CDS.

liquidity premium = corp bond spread - CDS premium??

So its like comparing a liquid risk free bond against an illiquid risk free bond?

yodacaia

@transferpricingcfa
you are implicitly assuming that there is no liquidity premium in the CDS market which is not true, there are large bid-ask spreads there and certain tenors wont trade at all or very rarely. there are academic studies attempting to quantify what portion of the CDS premium is pure default risk premium vs. illiquidity premium, with limited success. so you've just shifted your problem from "illiquidity in bond markets" to "illiquidity in CDS markets" without finding an answer unfortunately

@betaprivate
i agree with you that simple is good (if thats what you meant)! the reason why i wouldnt use these models in fixed income setting is not because they are too simple (or too complex), i just dont believe they produce anything more reliable than randomly adding a spread (of 25bps if you will) - even though they have the appearance of being so quantitative. they are a bit more trustworthy in the equity space cause more research and empirical support was done there, but only by a small margin...

NakedPuts

I see your point mobius and agree. never thought of that...

OK Take 2,

How about using covered bonds?

Liquidity premium = covered bond index yield - swap yield ?

jacksparrow

Yeah, all the theoretical models are ultimately crap given all the inputs are really subjective to a certain extent anyways, just have to look behind another curtain to find the one pulling the levers.

I like where the other conversation between you guys is going though - good stuff.