We study the dynamic impact of idiosyncratic volatility and bond liquidity on corporate bond spreads over time and empirically disentangle both effects. Using an extensive data set, we find that both idiosyncratic volatility and liquidity are critical mainly for the distress portfolios, i.e., low-rated and short-term bonds; for others only volatility matters. The effects of volatility and liquidity shocks on bond spreads were both exacerbated during the recent financial crisis. Liquidity shocks are quickly absorbed into bonds prices; however, volatility shocks are more persistent and have a long-term effect. Our results overall suggest significant differences between how volatility and liquidity dynamically impact bond spreads.

Researchers are often interested in modeling binary decisions made by firms (e.g., the yes or no decisions to split the shares, initiate a dividend, or acquire another firm) as functions of economy-wide variables (common factors). Although factor models for continuous dependent variables are used widely, the toolkit of a financial researcher does not contain a generally accepted methodology that allows estimating factor models for binary dependent variables. In this paper, we study such a methodology. Using simulations, we identify data characteristics that allow for reliable estimates of factor parameters and conclude that the methodology is appropriate for the panel datasets of the type often used in finance. As an illustration, we use the methodology to address a currently debated issue of common factors in firms’ decisions to split their shares.

We test the split signaling hypothesis by examining the reaction of sophisticated investors to stock split announcements. Return-based tests of signaling used in earlier studies produce conflicting results and have been criticized as unreliable. We overcome this issue by focusing on the long-term post-split behavior of short sellers, who are widely regarded as sophisticated investors. Upon controlling for alternative hypotheses and conventional short selling determinants, we find a substantial reduction in short interest in reaction to split announcements. Furthermore, consistent with signaling, the degree of the reduction is positively related to signal strength and to the splitter's level of information asymmetry. Overall, our results are consistent with the view that firms use stock splits to relay positive value-relevant signals.