Liquidity and Market Efficiency: Cash Corporates, ETFs, and CDX

Abstract

Market efficiency is an important topic for academics and practitioners. The main characteristic of efficiency is how accurately and quickly asset prices reflect available information. Among the reasons why they may not reflect this information is insufficient liquidity of the market. Using our proprietary measures of liquidity, we investigate the informational efficiency of the USD investment-grade corporate bond market. Our approach is to measure price inertia over time, which we consider a good proxy for market efficiency. Using both monthly and daily return series, we compare price inertia in 10 liquidity strata and find that the more liquid segments of the market have considerably less price inertia and are therefore considerably more efficient than the less-liquid segments. We also investigate the efficiency of corporate bond exchange-traded funds and CDX. We find that both display considerably less price inertia and more efficiency than even the most liquid segment of the traditional, cash corporate market and also lead that segment.