We examine the dynamics of bond correlation using a broad sample of US corporate bonds, and document that bond correlation varies heavily over time. We attribute this variation in bond correlation to variation in risk factor correlation reflecting time-varying flight-to-quality behavior of investors. We show that risk factor correlation increases when investor sentiment worsens, i.e., corporate bond investors exhibit stronger flight-to-quality when their sentiment is bad. Thus, bad investor sentiment leads to flight-to-quality behavior and, ultimately, high bond correlation. Very good sentiment, in contrast, can cause risk factor correlation and bond correlation to be negative.

Based on individual CDS transactions cleared by the Depository Trust & Clearing Corporation, we show that illiquidity strongly affects credit default swap premiums. We identify the following effects: first, transaction direction affects prices, as buy (sell) orders lead to premium increases (decreases). Second, larger transactions have a higher price impact. This finding stands in stark contrast to corporate bond markets. Third, traders charge higher premiums as a price for liquidity provision, not as compensation for asymmetric information. Fourth, buy-side investors pay significantly higher prices than dealers for demanding liquidity. Finally, inventory risk seems to matter little in explaining liquidity premiums.

We analyze the impact of market frictions on the trading volume and liquidity premia of finite-maturity assets when investors differ in their trading needs. Our equilibrium model generates a clientele effect (frequently trading investors hold only short-term assets) and predicts i) a hump-shaped relation between trading volume and maturity, ii) lower trading volumes of older compared with younger assets, iii) an increasing liquidity term structure from ask prices, iv) a decreasing or U-shaped liquidity term structure from bid prices, and v) spillovers of liquidity from short-term to long-term maturities. Empirical tests for U.S. corporate bonds support our theoretical predictions.

Human capital acquired while working in other industries before joining fund management provides fund managers with an information advantage. Fund managers exploit this advantage by overweighting their experience industries and by picking outperforming stocks from these industries. These managers’ superior information is impounded into stock prices slowly, suggesting that their information is unique and takes a while to be discovered by the markets. Families exploit their manager’s industry-specific human capital by broadly employing their investment ideas in other funds. The investment value of industry experience is unaffected by whether or not the manager with such experience is in a team. Received August 25, 2016; editorial decision December 24, 2017 by Editor Andrew Karolyi.