The Liquidity Spread: A Parsimonious Method for Data-Scarce Emerging Markets
Abstract
This paper develops a parsimonious method for estimating bond liquidity spreads in emerging markets where transaction data are scarce. It complements earlier work on credit spread decomposition, contributing to a unified valuation framework for data-scarce bond markets. The model was obtained analytically from a one-year holding-period return indifference condition between a liquid and an illiquid bond. It requires only two observable inputs: the bond’s yield bid-ask spread and its modified duration. An extension introduces an adjustment factor to capture volatile market conditions. The central result is a closed-form approximation: the minimum annual liquidity spread equals the product of the bond’s modified duration and its yield bid-ask spread. An illustrative application shows that liquidity costs can outweigh credit risk in thin markets. The framework offers a transparent and replicable alternative to arbitrary mark-ups, addressing a critical gap by providing a dedicated liquidity spread model tailored to data-scarce environments. Its primary innovation lies in its methodological parsimony, delivering a transparent valuation instrument that remains theoretically consistent even in the absence of transaction-level data.
References
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Amihud, Y. (2002). Illiquidity and stock returns. Journal of Financial Markets, 5, 31–56. https://doi.org/10.1016/S1386-4181(01)00024-6
Amihud, Y., & Mendelson, H. (1986). Asset pricing and the bid-ask spread. Journal of Financial Economics, 17, 223–249. https://doi.org/10.1016/0304-405X(86)90065-6
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Biais, B., & Green, R. C. (2019). The microstructure of the bond market in the 20th century. Review of Economic Dynamics, 33, 169–182. https://doi.org/10.1016/j.red.2019.01.003
Biais, B., Glosten, L., & Spatt, C. (2005). Market microstructure: A survey of microfoundations, empirical results, and policy implications. Journal of Financial Markets, 8, 217–264. https://doi.org/10.1016/j.finmar.2004.11.001
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Bongaerts, D., de Jong, F., & Driessen, J. (2017). An asset pricing approach to liquidity effects in corporate bond markets. Review of Financial Studies, 30, 1229–1269. https://doi.org/10.1093/rfs/hhx005
Brunnermeier, M. K., & Pedersen, L. H. (2009). Market liquidity and funding liquidity. Review of Financial Studies, 22, 2201–2238. https://doi.org/10.1093/rfs/hhn098
Chen, L., Lesmond, D. A., & Wei, J. (2007). Corporate yield spreads and bond liquidity. Journal of Finance, 62, 119–149. https://doi.org/10.1111/j.1540-6261.2007.01203.x
Committee on the Global Financial System. (2016). Fixed income market liquidity (CGFS Papers No. 55). Bank for International Settlements. https://www.bis.org/publ/cgfs55.htm
Comerton-Forde, C., Ford, B., Foucault, T., & Jurkatis, S. (2025). Investors as a liquidity backstop in corporate bond markets. HEC Paris Research Paper Series (No. 1564); Bank of England Staff Working Paper (No. 1126). https://doi.org/10.2139/ssrn.5229934
de Jong, F., & Driessen, J. (2012). Liquidity risk premia in corporate bond markets. Quarterly Journal of Finance, 2, 1250006. https://doi.org/10.1142/S2010139212500061
Dick-Nielsen, J., Feldhütter, P., & Lando, D. (2012). Corporate bond liquidity before and after the onset of the subprime crisis. Journal of Financial Economics, 103, 471–492. https://doi.org/10.1016/j.jfineco.2011.10.009
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Edwards, A. K., Harris, L. E., & Piwowar, M. S. (2007). Corporate bond market transaction costs and transparency. Journal of Finance, 62, 1421–1451. https://doi.org/10.1111/j.1540-6261.2007.01240.x
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Friewald, N., Jankowitsch, R., & Subrahmanyam, M. G. (2012). Illiquidity or credit deterioration: A study of liquidity in the U.S. corporate bond market during financial crises. Journal of Financial Economics, 105, 18–36. https://doi.org/10.1016/j.jfineco.2012.02.001
Galliani, C., Petrella, G., & Resti, A. C. (2014). The liquidity of European corporate and government bonds: Drivers and sensitivity to different market conditions (EUR Report No. 26498 EN). European Commission. https://publications.jrc.ec.europa.eu/repository/bitstream/JRC81644/lbna26498enn.pdf
Ghazaryan, A., Asoyan, S., & Melik-Parsadanyan, V. (2024). The credit spread: Risk-free rate in the model. Theoretical and Practical Research in Economic Fields, 15, 5–21. https://doi.org/10.14505/tpref.v15.3(31).11
Goyenko, R. Y., Subrahmanyam, A., & Ukhov, A. D. (2011). The term structure of bond market liquidity and its implications for expected bond returns. Journal of Financial and Quantitative Analysis, 46, 111–139. https://doi.org/10.1017/S0022109010000700
He, Z., & Milbradt, K. (2014). Endogenous liquidity and defaultable bonds. Econometrica, 82, 1443–1508. https://doi.org/10.3982/ECTA11039
Houweling, P., Mentink, A., & Vorst, T. (2005). Comparing possible proxies of corporate bond liquidity. Journal of Banking & Finance, 29, 1331–1358. https://doi.org/10.1016/j.jbankfin.2004.04.007
Hoyos, R., Liu, Y., Miao, H., & Saborowski, C. (2020). Who drains bond market liquidity in an emerging market? (IMF Working Paper No. 20/141). https://www.elibrary.imf.org/view/journals/001/2020/141/article-A000-en.xml
International Monetary Fund. (2023). Global financial stability report. https://www.imf.org/-/media/files/publications/gfsr/2023/october/english/text.pdf
Lesmond, D. A. (2005). Liquidity of emerging markets. Journal of Financial Economics, 77, 411–452. https://doi.org/10.1016/j.jfineco.2004.01.005
Longstaff, F. A. (2004). The flight-to-liquidity premium in U.S. Treasury bond prices. Journal of Business, 77, 511–526. https://doi.org/10.1086/386528
Longstaff, F. A., Mithal, S., & Neis, E. (2005). Corporate yield spreads: Default risk or liquidity? Journal of Finance, 60, 2213–2253. https://doi.org/10.1111/j.1540-6261.2005.00797.x
Mancini, L., Ranaldo, A., & Wrampelmeyer, J. (2013). Liquidity in the foreign exchange market: Measurement, commonality, and risk premiums. Journal of Finance, 68, 1805–1841. https://doi.org/10.1111/jofi.12053
Morningstar. (2013). Standard performance calculation methodology. https://www.morningstar.com/content/dam/marketing/apac/au/pdfs/Legal/StandardPerformanceCalculation_Methodology.pdf
Pastor, L., & Stambaugh, R. F. (2003). Liquidity risk and expected stock returns. Journal of Political Economy, 111, 642–685. https://doi.org/10.1086/374184
Roll, R. (1984). A simple implicit measure of the effective bid-ask spread in an efficient market. Journal of Finance, 39, 1127–1139. https://doi.org/10.2307/2327617
Sarr, A., & Lybek, T. (2002). Measuring liquidity in financial markets (IMF Working Paper WP/02/232). https://www.imf.org/external/pubs/ft/wp/2002/wp02232.pdf
Tuckman, B., & Serrat, A. (2011). Fixed income securities: Tools for today’s markets (3rd ed.). Wiley.
Vayanos, D. (1998). Transaction costs and asset prices: A dynamic equilibrium model. Review of Financial Studies, 11, 1–58. https://www.jstor.org/stable/2646036
Amihud, Y. (2002). Illiquidity and stock returns. Journal of Financial Markets, 5, 31–56. https://doi.org/10.1016/S1386-4181(01)00024-6
Amihud, Y., & Mendelson, H. (1986). Asset pricing and the bid-ask spread. Journal of Financial Economics, 17, 223–249. https://doi.org/10.1016/0304-405X(86)90065-6
Amihud, Y., & Mendelson, H. (1991). Liquidity, maturity, and the yields on U.S. Treasury securities. Journal of Finance, 46, 1411–1425. https://doi.org/10.1111/j.1540-6261.1991.tb04623.x
Bank for International Settlements. (2022). Annual economic report 2022. https://www.bis.org/publ/arpdf/ar2022e.pdf
Bao, J., Pan, J., & Wang, J. (2011). The illiquidity of corporate bonds. Journal of Finance, 66, 911–946. https://doi.org/10.1111/j.1540-6261.2011.01655.x
Biais, B., & Green, R. C. (2019). The microstructure of the bond market in the 20th century. Review of Economic Dynamics, 33, 169–182. https://doi.org/10.1016/j.red.2019.01.003
Biais, B., Glosten, L., & Spatt, C. (2005). Market microstructure: A survey of microfoundations, empirical results, and policy implications. Journal of Financial Markets, 8, 217–264. https://doi.org/10.1016/j.finmar.2004.11.001
Bodie, Z., Kane, A., & Marcus, A. J. (2021). Investments (12th ed.). McGraw-Hill Education.
Bongaerts, D., de Jong, F., & Driessen, J. (2017). An asset pricing approach to liquidity effects in corporate bond markets. Review of Financial Studies, 30, 1229–1269. https://doi.org/10.1093/rfs/hhx005
Brunnermeier, M. K., & Pedersen, L. H. (2009). Market liquidity and funding liquidity. Review of Financial Studies, 22, 2201–2238. https://doi.org/10.1093/rfs/hhn098
Chen, L., Lesmond, D. A., & Wei, J. (2007). Corporate yield spreads and bond liquidity. Journal of Finance, 62, 119–149. https://doi.org/10.1111/j.1540-6261.2007.01203.x
Committee on the Global Financial System. (2016). Fixed income market liquidity (CGFS Papers No. 55). Bank for International Settlements. https://www.bis.org/publ/cgfs55.htm
Comerton-Forde, C., Ford, B., Foucault, T., & Jurkatis, S. (2025). Investors as a liquidity backstop in corporate bond markets. HEC Paris Research Paper Series (No. 1564); Bank of England Staff Working Paper (No. 1126). https://doi.org/10.2139/ssrn.5229934
de Jong, F., & Driessen, J. (2012). Liquidity risk premia in corporate bond markets. Quarterly Journal of Finance, 2, 1250006. https://doi.org/10.1142/S2010139212500061
Dick-Nielsen, J., Feldhütter, P., & Lando, D. (2012). Corporate bond liquidity before and after the onset of the subprime crisis. Journal of Financial Economics, 103, 471–492. https://doi.org/10.1016/j.jfineco.2011.10.009
Duffie, D., & Singleton, K. J. (1999). Modeling term structures of defaultable bonds. Review of Financial Studies, 12, 687–720. https://doi.org/10.1093/rfs/12.4.687
Duffie, D., & Singleton, K. J. (2012). Credit risk: Pricing, measurement, and management. Princeton University Press.
Edwards, A. K., Harris, L. E., & Piwowar, M. S. (2007). Corporate bond market transaction costs and transparency. Journal of Finance, 62, 1421–1451. https://doi.org/10.1111/j.1540-6261.2007.01240.x
European Securities and Markets Authority. (2023). Consolidated Q&As on the PRIIPs regulation, including performance information at one year. https://www.esma.europa.eu/sites/default/files/2023-05/JC_2023_22_-_Consolidated_JC_PRIIPs_Q_As.pdf
Fabozzi, F. J. (2012). Bond markets, analysis and strategies (8th ed.). Pearson.
Friewald, N., Jankowitsch, R., & Subrahmanyam, M. G. (2012). Illiquidity or credit deterioration: A study of liquidity in the U.S. corporate bond market during financial crises. Journal of Financial Economics, 105, 18–36. https://doi.org/10.1016/j.jfineco.2012.02.001
Galliani, C., Petrella, G., & Resti, A. C. (2014). The liquidity of European corporate and government bonds: Drivers and sensitivity to different market conditions (EUR Report No. 26498 EN). European Commission. https://publications.jrc.ec.europa.eu/repository/bitstream/JRC81644/lbna26498enn.pdf
Ghazaryan, A., Asoyan, S., & Melik-Parsadanyan, V. (2024). The credit spread: Risk-free rate in the model. Theoretical and Practical Research in Economic Fields, 15, 5–21. https://doi.org/10.14505/tpref.v15.3(31).11
Goyenko, R. Y., Subrahmanyam, A., & Ukhov, A. D. (2011). The term structure of bond market liquidity and its implications for expected bond returns. Journal of Financial and Quantitative Analysis, 46, 111–139. https://doi.org/10.1017/S0022109010000700
He, Z., & Milbradt, K. (2014). Endogenous liquidity and defaultable bonds. Econometrica, 82, 1443–1508. https://doi.org/10.3982/ECTA11039
Houweling, P., Mentink, A., & Vorst, T. (2005). Comparing possible proxies of corporate bond liquidity. Journal of Banking & Finance, 29, 1331–1358. https://doi.org/10.1016/j.jbankfin.2004.04.007
Hoyos, R., Liu, Y., Miao, H., & Saborowski, C. (2020). Who drains bond market liquidity in an emerging market? (IMF Working Paper No. 20/141). https://www.elibrary.imf.org/view/journals/001/2020/141/article-A000-en.xml
International Monetary Fund. (2023). Global financial stability report. https://www.imf.org/-/media/files/publications/gfsr/2023/october/english/text.pdf
Lesmond, D. A. (2005). Liquidity of emerging markets. Journal of Financial Economics, 77, 411–452. https://doi.org/10.1016/j.jfineco.2004.01.005
Longstaff, F. A. (2004). The flight-to-liquidity premium in U.S. Treasury bond prices. Journal of Business, 77, 511–526. https://doi.org/10.1086/386528
Longstaff, F. A., Mithal, S., & Neis, E. (2005). Corporate yield spreads: Default risk or liquidity? Journal of Finance, 60, 2213–2253. https://doi.org/10.1111/j.1540-6261.2005.00797.x
Mancini, L., Ranaldo, A., & Wrampelmeyer, J. (2013). Liquidity in the foreign exchange market: Measurement, commonality, and risk premiums. Journal of Finance, 68, 1805–1841. https://doi.org/10.1111/jofi.12053
Morningstar. (2013). Standard performance calculation methodology. https://www.morningstar.com/content/dam/marketing/apac/au/pdfs/Legal/StandardPerformanceCalculation_Methodology.pdf
Pastor, L., & Stambaugh, R. F. (2003). Liquidity risk and expected stock returns. Journal of Political Economy, 111, 642–685. https://doi.org/10.1086/374184
Roll, R. (1984). A simple implicit measure of the effective bid-ask spread in an efficient market. Journal of Finance, 39, 1127–1139. https://doi.org/10.2307/2327617
Sarr, A., & Lybek, T. (2002). Measuring liquidity in financial markets (IMF Working Paper WP/02/232). https://www.imf.org/external/pubs/ft/wp/2002/wp02232.pdf
Tuckman, B., & Serrat, A. (2011). Fixed income securities: Tools for today’s markets (3rd ed.). Wiley.
Vayanos, D. (1998). Transaction costs and asset prices: A dynamic equilibrium model. Review of Financial Studies, 11, 1–58. https://www.jstor.org/stable/2646036
Published
2026-03-30
How to Cite
MELIK-PARSADANYAN, Vahagn.
The Liquidity Spread: A Parsimonious Method for Data-Scarce Emerging Markets.
Theoretical and Practical Research in Economic Fields, [S.l.], v. 17, n. 1, p. 192 - 199, mar. 2026.
ISSN 2068-7710.
Available at: <https://journals.aserspublishing.eu/tpref/article/view/9394>. Date accessed: 05 apr. 2026.
doi: https://doi.org/10.14505/tpref.v17.1(37).14.
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