Bid-Ask Spread, Volatility, and Volume in the Corporate Bond Market

Abstract

This article examines the time series relationship between the bid-ask spread and volatility and volume of the ten most actively traded bonds on the NYSE's Automated Bond System (ABS). A significant percentage of the trading in these bonds is carried out on the ABS, but retail-sized transactions and time-clustering mandate an approach that accommodates irregularly spaced quotes. Latent volatility for each bond is extracted using an autoregressive conditional duration model that provides input into an ordered probit model for observed spreads. For the most part, the authors find a significant positive relationship between latent volatility and observed spread, and a negative relationship between a trading volume