Corporate Bond Transactions and Liquidity: The Probability of Execution

To capture the multiple dimensions of liquidity in the corporate bond market, we combine a model of imputed transaction costs with a model that estimates the fraction of transactions that involve dealer inventory. We connect this to a third model that estimates the arrival rates of buyers and sellers in the market. The resulting expression captures the probability of successfully executing a trade on a bond within a day, for a given target execution cost. We propose this measure, abbreviated as PEX, the Probability of Execution, as a new bond-specific liquidity proxy. By investigating various liquidity determinants that influence the individual models, we are able to identify the bond characteristics and market conditions that influence the PEX. We find that a bond's total amount outstanding, the yield spread, duration and transaction volume of the previous month are the most influential variables. This study provides first evidence that the PEX is a viable alternative to more naive liquidity estimators and can benefit applications ranging from bond selection to trade execution and post-trade transaction cost analysis.