Liquidity Spillover in the Corporate Bond Market

Abstract In this study, I examine liquidity spillover in the corporate bond market. Using regulation‐induced selling pressure in the corporate bond market following rating downgrades from investment grade to high yield, I document that liquidity shocks to downgraded bonds spill over to their peer bonds that are issued by firms with high fundamental volatility, to a small number of economically related peer bonds, and to peer bonds that show a higher degree of learning, as indicated by a high correlation between trading volume and return volatility. The empirical evidence supports the cross‐asset learning hypothesis, suggesting that liquidity contagion from one asset to others arises through information learning across assets.