The growth of Malaysian bond market can be traced back in 1970s, when the government started issuing bonds to meet the massive funding needed to boost up the country's development. While, corporate bond market in Malaysia started to develop since mid 1980's. In early year of bond market development, most of the corporate funding relied on finance from banks. As the government and corporate sector realized the important role of a fruity bond market development as a key strategic development of the Malaysian economy and as another source of funding, it has been aimed to be as the main driver of economy growth as well as growth in the corporate sector.
Figure 1: Establishment of regulatory bodies and guidelines in Malaysian Bond Market. Source: Rating Agency Malaysia
Establishment of BIDS
Started since 1989, numerous regulatory frameworks, structural changes and issuance guidelines have been initiated by central bank, credit rating agencies, national bond committee, securities commission and other critical institutions (figure 1). These are seen as main drivers of soundness growth in bond market in particular to corporate bond market.
After the past 20 years, efforts develop the Malaysian bond market have been fruitful. In terms of relative size of the bond market versus domestic bank credit, growth has been quite significant. Another notable achievement is the successful promotion of the Islamic bond market. Islamic bonds have played a major role in Malaysia's capital market development and until these recent years, corporate bond market still growing.
As the market develops, the concern of bond liquidity also escalates in number by many scholars, market participants and authorities as they recognized the importance of liquid bond market as a role in enhancing the market's resilience during the time of financial stress, source of funding as well as another device for superior economic soundness; contribution to the country such as gross GDP (figure 2 and table 1).
Figure 2: % of corporate bond contribution towards Malaysia's GDP from 1970s until 2000. Source: Rating Agency Malaysia
Table 1: % of corporate bond contribution towards Malaysia's GDP in 2009. Source: Asian Bond Online
In early 1980, the corporate bond market was virtually non existent in Malaysia. This was contrast to the bank loan and government debts market, both of which had achieved a reasonable level of sophistication and maturity by the time where they contributed 30.7% and 32.7% of GDP in 1980s. However, as corporate debt market develops with the helps of initiatives generated by the said parties, its contribution towards countries GDP escalated from 2% in 1990s to 21% in 2000s (figure 2) and raised to 37.6% at the 3rd quarter of 2009 (table 1). The trend is expected to gradually increase along with the enlargement of bond market.
Though, corporate bond market has been growing tremendously, has been proven as one of the contributors to GDP and offers the corporate sector alternatives source of finance, several issues and challenges remain. In particular, liquidity in the secondary market need to be improved to a level comparable to that in Malaysian government securities also to a level comparable with those initiatives that have been developed. Therefore, an investigation should be carried out to first understand determinants of liquidity in particular to Malaysian corporate bond market. Hence, improve the liquidity of bond market in particular to secondary market.
Despite the said benefits will be contributed if having a very liquid bond market, other significant issues should be noted down to strength up the needs of conducting the study. First, though Malaysian bond market is a small market with only USD 81 billion compared to US market USD1092 billion at the 4th quarter of 2009 but it is a diverse market with the heterogeneity of its instruments and sophisticated infrastructures. Thus it compares as favorable market to be studied.
Next, two segment of bond exists in Malaysia; Islamic and conventional. Liquidity tends to concentrate at only one segment or may be both; hence it could bring different detrimental impact on corporate bond liquidity. At the same time, the growth and development of Islamic bond at present years will potentially increase the diversity of the investor base and finally boost up the trades in Islamic bonds and improve degree of liquidity (exhibit 1). This could be another new element explored to determine liquidity in the studies with regard to bond markets.
STATEMENT OF PROBLEM
Numerous issuing guidelines, strategic development initiatives and even structural advancement developed by securities commissions, credit rating agencies, central bank, bond market committee and other relevant bodies helps to develop the Malaysian bond market. However it was insufficient to further improve the liquidity in corporate bond market in particular to secondary market.
A comparison made between corporate bond market in Malaysia and other developing countries found that even though efforts and initiatives have been placed in, still Malaysia domestic market is ranked as far below China and lower than Korea (figure 3). It is understood if different market characteristic brings different preferences towards the use of debts securities as alternate source of funding, however if solely based on the encouragement and efforts given by the government, there should be justifications of why liquidity in Malaysian bond market still need further improvement.
Figure 3: Liquidity level which represented by turnover ratio of developing countries. Source: Rating Agency Malaysia
At the same time, priory the lights given by previous studies often centered in other developed and developing market; US, Thai and Euro market. It is rare to be extensionally studied in an emerging bond market particularly Malaysian bond market.
For the said justification, this study also seeks to fill up the gap of previous unexploited scope and limitations, hence to switch on the light onto Malaysian market in particular to corporate bond market. The study intends to thoroughly understand pattern of corporate bond market by plotting the focus at determinants of liquidity. It comes with the hope to piece together the jigsaw to reveal the puzzlement of lower liquidity, hence impose suitable recommendations to boost up the liquidity in Malaysian bond market.
1.2 OBJECTIVES OF THE STUDY
1.2.1 To examine determinants of liquidity in developing corporate bond market; Malaysia.
1.2.2 To determine a major contributor of liquidity and ways of detrimental impact that yield volatility, credit risk, issuance size, maturity, equity market condition and segment of bonds have on liquidity.
1.2.3 To investigate whether structural changes have done the most to promote liquidity.
RESEARCH QUESTIONS
This research is conducted with the aim to answer the research questions as follows:
1.3.1 Are the determinants of liquidity in developing bond market; Malaysia same as other studied markets?
1.3.2 How detrimental an impact do yield volatility, credit risk, issuance size, maturity, equity market condition and segment of bond have on liquidity?
1.3.3 Which structural changes have done the most to promote liquidity?
SCOPE OF STUDY
The study attempts to analyze factors that determine degree of liquidity in Malaysian corporate bond market. Corporate bond market consist sample of bond issued by Cagamas, Khazanah, and private corporations.
Seven types of variables employed in the study; trade volume, yield volatility, issuance size, credit rating, maturity, equity market condition and segment of bond; Islamic and conventional.
A daily historical transactions data will be observed for all variables which covered the period of 1999 until 2011.
Data of bid ask spread, yield, issuance size, maturity and segment of bonds is expected to be gathered from Pricing Bond Agency Malaysia (PBAM). The PBAM is an initiative by the Securities Commission of Malaysia to further boost the transparency and quality of price discovery mechanisms and valuation practices in the Malaysian bond market. It was officially appointed as Malaysia's first Bond Pricing Agency on April 2006. PBAM is recognized as one of the official sources for evaluated prices on ringgit denominated bonds.
Data with regard to bond's rating will be collected from two rating agencies in Malaysian; Rating Agency Malaysia (RAM) and The Malaysian Rating Corporation (MARC). All type of bond's rating will be used without intends to eliminate any of it. For a proxy of equity market condition, a daily historical data of KLCI will be used and obtained from Bursa Malaysia.
Both Islamic and conventional type of bond will be observed to be used as sample as it could be as a new element in the study of bond liquidity. This consists trading held in primary and secondary market.
SIGNIFICANCES OF THE STUDY
Several significances identified by the study are as follows:
As liquidity closely related to total amount of trades in the bond market and lower transaction cost, any of bond market is anticipated to have a continuous increase in trades and infinite drop in costs in both primary and secondary market. Contribution that corporate bond market brought into national GDP has increased since 1980s. From nil % recorded in early 1980s, it raised near to 38% of national GDP in 2009. Therefore, the anticipated finding could not only come in to answer the determinants of liquidity; hence help to initiative efforts for further rise up the trades in bond market in particular to secondary market. Finally, it could give infinite growth to national GDP and expand the Malaysian economy.
Malaysian bond market is improving in terms of trade volume since the last 20 years. However, a comparison made with other developing countries; China and Korea that have liquid bond market in particular to corporate bond market shows that Malaysian bond market is ranked as far below the said countries. Indirectly, our market is looking at those markets as our benchmark to further improve our domestic market. However, if Malaysian bond market can be as liquid as those said markets, a new benchmark can be created as Malaysia is now seen as a pioneer for Islamic bond market, thus be a new reference in terms of our systematic guidelines and regulatory frameworks that can be copied and implemented by other developing market in Asia
Regulatory bodies such as central bank, Securities Commission, Bond Pricing Agency Malaysian, Credit Rating Agencies plays major roles in initiating and providing guidelines and framework in helping the improvement in corporate bond market. Most of the efforts focused at promoting more trades in corporate bond. Therefore, from the finding that will be generated, it could help those related bodies to have a clear picture of determinants for liquid bond market. Hence, continuously reviewing the existent guidelines to aggressively promote the corporate bond development. Finally, national GDP could again be benefited from the increase in corporate bond trading.
Corporations or issuers are seen as another benefited party by the study conducted. As Asian financial crisis 1997-1998 proves enough of how corporations should not be relying at only one source of funding, it is important to develop another reliable source of funding that allows corporations to match their assets-liability profile. Mean while, it provide the opportunity to address capital needs more effectively. Potentially, with more trades on corporate bonds could help corporations achieve their financial objective.
A concern of risk diversification also being a crucial reason of why the study is significant to corporations. As another efficient source of financing needed, it is comes with the need to avoid corporations from an excessive risk of bankruptcy. The increase in bond liquidity could possibly reduce the risk suffered by corporations. However, an improvement of corporate bond liquidity should be made by first identifying its determinants.
Investors also will significantly affected by the study conducted. As the study intends to look after the determinants of liquidity, it is comes along with the hope to further improve the liquidity level. The more trades can be generated, the lower transaction cost that the investors will be offered. Hence, it will help investor to enjoy lower cost of trading besides providing them with other suitable and efficient medium of investment.
CHAPTER TWO: REVIEW OF LITERATURE
2.1 Development of Malaysian Bond Market
Started since 1989, numerous regulatory frameworks, structural advancement and guidelines have been initiated by central bank, credit rating agencies, national bond committee, securities commission and other critical institutions.
In December 1988, the Central Bank issued guidelines concerning the issuance of corporate bonds, prescribing the qualifications of issuers (minimal capital, highest limit of debt ratio, minimal issuing amount of 25 million ringgit and so on). In May 1992, first rating agency is established to provide rating to corporate bonds and provide independent opinions for potential risk of corporate issuers. In October 1995, second credit rating agency; Malaysian Rating Corporation Berhad (MARC) is developed with the same objectives.
Prior to the establishment of MARC, Securities Commission (SC) was established in March 1993 that acts as a single regulatory body to promote the development of capital market such as approving authority for corporate bond issues. In Sept 1997, Bond Information and Dissemination System (BIDS) were established. BIDS was one of the most comprehensive corporate bond trading databases ever assembled in Malaysia.
The 1997-1998 Asian financial crises brought home the folly of over reliance on bank loan. An eventual credit squeeze suffered by corporate sector during that Asian financial crisis highlighted the importance of risk diversification within the financial system. However, a lack of a well developed market prevented the objective of risk diversification.
Lessons learnt from the crisis lead government and other regulatory bodies to aggressively step up their efforts to further enhance the development of corporate bond market.
As for the result, in July 2000, the issuing procedures of corporate bonds were simplified by the Securities Commissions. The procedures are as follows:
The authority to approve the issuance was concentrated in the SC.
Preliminary examination by the SC of the merit of the issuance was abolished.
It was decided that the approval for issuance must be given within 14 days after applications
A shelf registration scheme was introduced.
Source: Shimizu (2008)
In 2004, capital control was eased and it enables issues of ringgit- denominated bond by international institutions and multi national corporations became possible. After the change:
Asian Development Bank issued ringgit bond in November 2004
International Finance Corporations in December 2004
World Bank in May 2005
In 2008, Electronic Trading Platform (ETP) was introduced to replace Bond Information and Dissemination System (BIDS) as post trade transparency medium to facilitate efficient trading and increase liquidity in the over the counter debt securities market.
Liquidity In Malaysian Bond Market
Tremendous efforts that have been placed by authorities sometime do not really set a remarkable liquid bond market as what happening in few Asian developing countries. The level of trading volume is still not at the level as what it is hoped even though the needs and importance of having one liquid bond market is undeniable. A set of literatures confirmed how liquid bond market helps in boosting up the economy expansion; Mahanti et. al (2008), Shimizu (2008), Chabchitrchaidol and Panyanukull (2005) and Wong and Muhamad (2006).
However, as again confirmed by some literatures, Chabchitrchaidol and Panyanukull (2005), Shimizu (2008) and Mohammad and Wong (2006), liquidity in the secondary market in particular to Malaysian corporate bond is still at the early life stage. Surprisingly, even under the active easing regulation and many other initiatives with regard to the bond market development, still degree of liquidity need to be improved.
Briefly, liquidity of bond market often been referred by the higher outstanding volume of trade, bond turnover ratio and lower transaction cost (measured by bid ask spread). The fact (chart 1) confirmed that liquidity is improving but still infancy.
Chart 1: Bid Ask spread for Malaysian corporate bond. Source: Asian Bond Online (2010)
Zoom in at one of the proxies of corporate bond liquidity; bid ask spread, it is clear (chart 1) where the spread in corporate bond shown an increasing pattern where it indicates that the spread is getting tighter. Since February 2004 until December 2009, the spread dropped to 16 point basis from 20 point basis. Hence it indicates that liquidity in corporate bond is improving.
Measures of Liquidity
There is no standard definition of market liquidity. That said, there is only a general understanding of the nature of liquidity. Often, academics and practitioners use common accepted definitions and measures of how to examine degree of liquidity. As confirmed by Houweling et. al (2005), Mahanti et. al (2008) and Chaudry (2009), the definition of liquidity is depending on what measures every different people employed.
A great deal of literatures explains various measures of liquidity. Generally, liquidity has at least three dimensions; tightness, depth and resiliency:
Tightness refers to trading cost, specifically how far transaction prices diverge from the mid market price. It is often calculated by the spread of bid and ask price.
Depth refers to the volume of trades
Resiliency refers to the speed
As above described, a liquid market can be defined as one where there is a possibility for market participants to transact buy or sale transactions at any time (during opening hours) in size, at no extra cost, without this causing price to move. In common way, it is measured by calculating the spread between bid n ask price. Theoretically, as spread tighter, the cost of securities traded will be lower. Thus increase the liquidity.
Numerous studies employed the spread of bid and ask as a proxy to measure liquidity in the studied market. Studies by Chabchitrchaidol & Panyanukull (2005) calculated the spread to examine level of liquidity in Thai bond market, Chaudry (2009), used in the studies of US bond market and Houweling et. al (2005) for Euro bond market.
An explanation have been placed to justify why the spread of bid and ask often being the number one option to measure liquidity. As what have been quoted by Edward et.al (2007) as cited by Bao et. al (2009)..
.." A simple measure of corporate bond liquidity is the effective bid-ask spread and the bid ask spread is seen as direct and an important indicator of bond liquidity"..
As discussed by Chabchitrchaidol & Panyanukull (2005), the most comprehensive measure of trading cost is the effective spread, defined as the transaction price less the mid point of quoted bid and asks prices. This measure incorporates with price movement triggered by the trade itself. This measure used by Goldstein et. al (2005). However, it is problematic to construct effective spread if the quotation data is not available. Thus realized bid ask spread will be computed to overcome the weakness.
Second said measurement of liquidity is depth which denoted by the amount of orders at a given time. Theoretically, as trading volume become higher, liquidity level also improve. This measure employed by Hotchkiss and Jostova (2007) in the study of US bond market.
Two critiques found to explain the use of trading volume as proxy. First, as according to Hotchkiss and Jostova (2007), volume of a large, small trades and total volume are highly correlated. Thus is can employ is any bond market even if the trades are lower.
Second, it is a best replacement for market where the quotation data to compute the effective or realized spread of bid and ask is not really available. In some markets, the daily transaction data is not publicly revealed; hence it creates a difficulty of computing the spread. Therefore, second measure is seen as suitable to overcome the limitation.
Determinants of Liquidity
2.4.1 Characteristics of Bond
After several reviews have been done, variety of bond's characteristics identified to have a significant correlation with degree of liquidity. Studies done by Mahanti et.al (2008), Nielsan et. al (2009), Hotchkiss and Jostova (2007), Houweling et. al (2005), Chabchitrchaidol & Panyanukull (2005) and Chaudry (2009) examined size of bond issued as main characteristic that potentially affect liquidity.
The issue size is identified as the face value of the amount outstanding for bond i on the day t, often measured in particular currency of the studied market. The rationale usually given is that the supply potentially available for trading is greater than larger issues. The result for the first characteristic studied indicated that most of the cases agreed that liquidity perceived to be positively correlated with the size of bond.
Credit risk is a second characteristic often been examined as determinant for liquidity. Credit risk is represents the riskiness of securities represents the creditworthiness of one's corporation and measured by credit rating. Credit risk also known as the abilities of one's issue carries lower defaulting risk.
Hotchkiss and Jostova (2007) indicated uncertainty concerning value is likely to be higher for lower credit quality issues. Therefore concluded that confirmed that spreads on A-rated bonds significantly higher than spreads on a guaranteed bond and those categorized into AAA-rated bonds. This have been supported by Chabchitrchaidol & Panyanukull (2005), Chaudry (2009) and Hotchkiss and Jostova (2007) themselves whom confirmed that the higher the probability of default (therefore the lower the credit rating), the higher the degree of liquidity.
However, Mahanti et.al (2008) in their study indicated the credit quality of a bond appears to be inversely correlated to liquidity. As added, this is a surprising result because most people tend to associate high credit rating with high liquidity. The simple explanation given is that, bonds that have high quality are usually held in long term buy and hold investors such as insurance companies which have long term liabilities and hold fixed income assets for assets liability matching reason, because these bonds are less likely to default.
Bond maturity also argued as another crucial variable that plays a role in examining the effects on liquidity. Maturity is defined as the difference between the maturity dates at day t, measure by years. However, there are studies separated maturity into two; current maturity and original maturity. Original maturity is observed using the original maturity of the bond at the time of issues. This separation has been used by Mahanti et.al (2008).
Hotchkiss and Jostova (2007), Chaudry (2009), Nielsan et. al (2009) and Bao et. al (2009) argued that as bond becomes more seasoned, it contributes to less number of trading, hence less liquid. The theory has been confirmed in the studies conducted by them. As added, maturity also in certain ways carries the risk of defaulting where as maturity becomes longer, the defaulting risk tend to be higher, hence reduce the liquidity which resulting from lower trading volume. As described, one of the measures of liquidity refers to the amount of trades.
Yield volatility seems to have a positive correlation with bid ask spread (a negative impact on liquidity). Intuitively, an increase in volatility poses higher risk, which need to be compensated directly through a higher bid ask spread. There are many ways of calculating yield. One common method is based on a daily standard deviation of yield changes over a period of X observations (working days) that measured in percent. Chabchitrchaidol & Panyanukull (2005) applied this measure in their study.
As suggested Houweling et. al (2005), an important source of yield uncertainty is related to the predictability of future yield movements. They also hypothesized that higher yield volatility leads to the higher bid ask spread; hence result to the lower liquidity. The theory confirmed by Hotchkiss and Jostova (2007) where found the same correlation between yield volatility and spread.
Coupon rate is another tool used to determine degree of liquidity. Studies by Mahanti et.al (2008), Chabchitrchaidol & Panyanukull (2005), Goldstein et. al (2005) and Tishchenko (2004) have applied this variable. In theory, coupon rate can be defined as the interest paid per year expressed as a percentage of the face value of the bond.
Based on Mahanti et.al (2008), they however emphasized that there is no clear relationship between coupon rate and trading volume. Therefore, there is no evidence to stress out that higher coupon rate will lead to higher trading volume, thus increase liquidity. In their study as well, they suggested that may be trade volume could potentially have a correlation between types of coupons given (either bonds pays fixed or floating rate) and trade volume. However, this only in theoretical manner and has not been examined in their study.
Unlikely, a study of US bond market by Tishchenko (2004) found that coupon rate possess a positive relationship with trading volume.
Other characteristics studied include industry of issuers. Trading activity may be different across industry groups due to differences in industry regulations and market outlook. From several reviews made, only Hotchkiss and Jostova (2007) applied this variable in their studies. The result shows that industry does not have a strong impact on bond trading. They added, high yield bonds of industrial and financial firms do trade less than bonds of utility bonds. Hence they concluded that impact from industry of the issuers on bond trading is generally small.
2.4.2 Market Confidence
There are few studies suggested that market conditions does play a role in modifying degree of liquidity. As what have been quoted by Bario (2000) that cited by Chabchitrchaidol and Panyanukull (2005)..
.."Macroeconomic factors that come in various aspects may also play a role in determining market liquidity. However, points out that the factors determining liquidity or the degree significant can differ substantially during of market stress"..
Mahanti et.al (2008) suggested that market condition on day t can have an important impact on spreads. Increased uncertainty about macroeconomic or financial conditions might lead market makers to reduce their risk exposure, hence resulting to deterioration in market liquidity. As a proxy for market condition, a daily return on equity index is computed.
Similar to the study by Hotchkiss and Jostova (2007), they found that financial market condition influence bond trading as investors optimize and rebalance their portfolio in light a new confirmation. Their finding denotes that positive correlation existed between market volatility (that proxied by daily return of NYSE-stock) and trading volume of bonds.
Another important point noted down by Chabchitrchaidol and Panyanukull (2005). They emphasized that size of an economy tends to correlate positively with the size of the bond market- with a small market limiting the feasible range of marketable instruments and their effective tradability. Refers to the European experience, bond market becomes deeper after the adoption of a common market and currency.
CHAPTER THREE: RESEARCH METHODOLOGY
Research Design
The study relies on the secondary data and statistics as provided by some databases. Suitable formulas, theories and equation will be employed to measure the dependant variable and explanatory variables and will be referring from previous studies. Briefly, the study is a cross sectional study that consists observations of daily historical transaction trading for the period of 1999 until 2011.
The basic least squares equation to be estimated is as follows:
VOL = α + β1 Volatility + β 2 CreditRisk dummies + β 3 IssuanceSize + β 4 Segment dummies + β5 Maturity + β6 MarketReturn + β7Industry + E
Where:
α = A constant number of the equation or volume- intercept
β1...β6 =Slopes that are amount of increase (decrease) in the deterministic volume of trades.
E = Error of estimation
Measures and Formulas Applied
Formulas and equations employed for dependant variable and every single independent variable are as follows:
Corporate Bond Liquidity
First, to examine the level of corporate bond liquidity (dependant variable), volume of trades will be applied as a proxy. Numerous literatures; Houweling et. al (2005), Chaudry (2009) and Hotchkiss and Jostova (2007), employed this measure in their studies. Although bid ask spread recorded highest number of its application as liquidity's measure, but often used in measuring liquidity, there are two justifications of the application of this proxy;
The lack of bid ask spread data available to compute realized bid ask spread avoids the intention to use spread of bid and ask as a proxy. Therefore, the best replacement to measure market liquidity is by utilizing volume of trade.
Volume of trades can be exercised even if the market experiencing lower trading (low liquidity). As according to Hotchkiss and Jostova (2007), volume of a large, small trades and total volume are highly correlated.
The equation is as below:
Source: Hotchkiss & Jostova (2007)
Where:
Amount outstanding = Amount of trades for bond I at day t
The volume of trades indicates that as trades increase, market becomes liquid.
Yield Volatility
There are different ways of calculating volatility. The computation is based on what employed by Chabchitrchaidol and Panyanukull (2005), Hotchkiss and Jostova (2007) and Houweling et. al (2005). This study will generate a data series for computed yield based on end day quoted price and on a daily observations (working days) measure in percent (%). The approach is as follows:
Source: Panyanukul and Chabchitrchaidol (2005)
Where:
= Number of trading days
= Bond price at date t
= Average bond price over the last 21 trading days (calendar month proxy)
Yield volatility is expected to have a negative relationship with trade volume. Intuitively, it will be possessed a positive impact to bond liquidity. An increase in volatility will possess higher risk where trade volume will drop. Therefore it will give an adverse impact to liquidity.
Market Return
As denoted by Mahanti et.al (2008) and Hotchkiss and Jostova (2007), financial condition plays a role in determining liquidity. An ARCH model called as GARCH will be employed to examine market return. Application of GARCH model has been discovered in 1987 to measure return and risk of financial assets. To compute market return, a daily return on day t for KLCI-stock will be observed.
The model of market return is expressed as follows:
Source: Azami et. al (2009)
Where:
= Kuala Lumpur Composite index at day t
Market return is expected to have positive relationship with trade volume. Theoretically, it possesses a positive correlation with liquidity.
Credit Risk
Credit risk is proxied by credit rating dummies; based on bond ratings. The study defines 5 dummies which categorized into AAA, AA, A, BBB and guaranteed. Even though the minimum rating requirement on credit rating distributed as D, the credit profile of corporate bonds remains skewed towards the higher end of the credit spectrum (A and above), with approximately 5% of outstanding issues rated BBB or below (chart 3). This reflects investor's risk preference for high quality bonds issues. For that reason, only five categories of rating will be employed.
Rating dummies are as follows:
Rating dummies
Guaranteed
AAA
AA
A
BBB
Chart 3: Rating Distribution for Corporate Bond Issues. Source: MARC and RAM
Bonds guaranteed by the Malaysian government are not rated by the local agencies; therefore it will enter into guaranteed category. There are two issuers which will enter into this category, bond issued by Cagamas and Khazanah. All bonds have only one rating. Rating is expected to have positive correlation with trading volume.
Issuance Size
Issuance size represents the size of bond i issued at day t by issuer a; measured in Ringgit. It simplifies as follows:
Issuance Size = Amount of bond i issued at day t by issuer a
Source: Mahanti et. al (2008)
Issuance size is expected to have a positive relationship with trading volume. As said, issuance size is measure in Ringgit Malaysia and will be entered into estimation as it is.
Maturity
Maturity represents the age of the bond issued at day t by issuer a; measured in years. It simplifies as follows:
Maturity = Age of bond i issued at day t by issuer a
Source: Panyanukul and Chabchitrchaidol (2005)
As according to Bond Pricing Agency Malaysian (BPAM), there are seven different tenors of corporate bonds issued:
Bond Tenor (years)
1
3
5
7
10
15
15+
Maturity is predicted to have negative relationship with trading volume. Whenever maturity becomes longer, the trades becomes lower. A rationale is that longer time to maturity leads to higher defaulting risk, hence contribute to less trades. Bond maturity that measured in years will be entered into estimation as it is.
Segment of bond
Final explanatory variable employed in the study is segment of bond. This predicted determinant has not been explored by the previous studies. However, due to some special features in Malaysian bond market, where it consist two segments of bond; conventional bond and Islamic bond, this variable is seen as suitable to be applied. Since Malaysia consists to segment of bond, it is uncertain to predict which segment contributes more to the degree of liquidity. Therefore this potential determinant will be also studied as determinants of trade volume.
This study applied dummy variable for this variable:
Segment of bond
Conventional issues
Islamic issues
There are several other justifications of applying segment of bond in this study:
Given that potential investors for Islamic bonds are larger than the conventional bond. Non Islamic investors can invest in both conventional and Islamic bond; however Islamic investors usually invest only in Islamic bonds. Therefore, this difference can be potentially distracting the liquidity.
Second, Islamic bond is more complex instrument like asset backed securities. Hence it could also differentiate the degree of liquidity that resulting from less trade volume of Islamic bonds.
Third, rapid growth in Islamic bond at this recent years came by the structural changes to promote Islamic bond issuance could also be another rationale of a difference in liquidity's degree.
Suggested Theoretical Framework
Yield Volatility
Credit Risk
Issuance Size
Corporate Bond Liquidity
Maturity
Industry's of the Issuer
Market Return
Segment of Bond
Independent Variables Dependent Variable
Dependant Variable
* Corporate bond liquidity
Independent Variables
* Yield volatility
* Credit risk
* Issuance size
*Maturity
*Equity market condition
*Segment of Bond
Table 2: A summary of predicted signs and proxies of predictor and explanatory variables
Variables
Proxies
Predicted Signs of Relationship
Reasoning
Yield Volatility
Sources: AsianBondOnline (2010), Hotchkiss and Jostova (2007), Houweling et. al (2005) and Chabchitrchaido and Panyanukull (2005)
Negative
Increase in yield volatility indicates lower trades, hence lower liquidity.
Credit Risk
Credit rating dummies
Sources : RAM and MARC
Positive
A good credit rating promises higher trades, Therefore high liquidity
Issuance Size
Issuance size is expressed as:
Source: Mahanti et. al (2008)
Positive
A larger issuance size suggests greater liquidity resulting from higher volume of trades
Maturity
Time to maturity simplified as:
Source: Panyanukul and Chabchitrchaidol (2005)
Negative
Longer term of maturity increases the probability of defaulting. Hence, drops volume of trades and reduces liquidity
Market Return
Measure of market return as follows:
Source: Azami et. al (2009)
Positive
Market return is expected to have positive relationship with trade volume. Increase in return, will increase trades, and hence increase liquidity.
Segment of Bond
Segment dummies:
Uncertain
Corporate Bond Liquidity
Volume of trades:
Sources: Tishchenko (2004), Hotchkiss and Jostova (2007), Houweling et. al (2005) and Chaudry (2009)
-
-
Statement of Hypotheses
There are six hypotheses were developed and mention as follows:
Hypothesis 1
H10: There is no significant relationship between yield volatility and corporate bond liquidity.
H11: There is a significant relationship between yield volatility and corporate bond liquidity
Hypothesis 2
H20: There is no significant relationship between credit risk and corporate bond liquidity.
H21: There is a significant relationship between credit risk and corporate bond liquidity
Hypothesis 3
H30: There is no significant relationship between issuance size and corporate bond liquidity.
H31: There is a significant relationship between issuance size and corporate bond liquidity
Hypothesis 4
H40: There is no significant relationship between market return and corporate bond liquidity.
H41: There is a significant relationship between market return and corporate bond liquidity
Hypothesis 5
H50: There is no significant relationship between maturity and corporate bond liquidity.
H51: There is a significant relationship between maturity and corporate bond liquidity
Hypothesis 6
H60: There is no significant relationship between segment and corporate bond liquidity.
H61: There is a significant relationship between segment and corporate bond liquidity
Data Collection Method
The study relies on the secondary data and daily historical transactions data and statistics provided by few data bases. A daily data and observation with regard to volume of trades, yield volatility, bond maturity and issuance size will be gathered from Bond Pricing agency Malaysia (BPAM). All data covers the transactions period of 1999 until 2011. Briefly, BPAM is an initiative by the Securities Commission of Malaysia to further boost the transparency and quality of price discovery mechanisms and valuation practices in the Malaysian bond market.
Data for Kuala Lumpur composite Index (KLCI) will be compiled from the historical data of Bursa Malaysia. A daily index used in this study covered the period of 1999 until 2011 and will be applied to measure market return.
Information with regard to the rating of each bond will be collected from two rating agencies; Rating Agency Malaysia (RAM) or The Malaysian Rating Corporation (MARS). It consist rating of bond that issued back in 1999.
Other related and relevant data will be gathered from several other websites; Asian Bond Online (http://www.asianbondsonline.adb.org), Bond Info Hub (http://bondinfo.bnm.gov.my) and other related websites.
An external secondary data will be retrieved from articles, journal, reports, newspaper and other possible sources. Once desired data are collected and computed, it will be analyzed using SPSS program to see the significant correlation that could potentially exist between variables as described.
References
Azami Zaharim, Siti Meriam Zahid, Mohammad Said Zainol & Ibrahim Mohamed. (2009). "Modeling the Kuala Lumpur Composite Index (KLCI)". Journal of Scientific Research, Vol. 23, No. 3, Pg 449-515. Retrieved on 16th April 2010.
Bao J. & Pan J. (2008). "Excess Volatility of Corporate Bonds". Journal of Financial Management. Retrieved on 26th March 2010.
Bao J., Pan J. & Wang J. (2009). "Liquidity of Corporate Bonds". Retrieved on 5th April 2010.
Bessembinder H. & Maxwell W. (2008). "Transparency and the Corporate Bond Market". Journal of Economic. Retrieved on 2nd April 2010.
Bushman M. R., Le A. & Vasvari P. F. (2010). "Implied Bond Liquidity". Retrieved on 2nd April 2010.
Chabchitrchaidol A. & Panyanukull S. (2005). "Key determinants of Liquidity in the Thai Baht Market". Retrieved on 1st April 2010.
Chacko G. & Mahanti S. (2005). "The Determinants of Liquidity in the Corporate Bond Market". An Application of Latent Liquidity. 2nd of April 2010.
Chen L., Lesmond A. D. & Wei J. (2005). "Corporate Yield and Bond Liquidity". Retrieved on 19th March 2010.
Choudhry M. (2009). "The Value of Introducing Structural Reform to Improve Bond Market Liquidity": Experience From the UK GILT Market. Journal of Finance and Banking, vol. 2, No. 2. Retrieved on 4th April 2010.
Edwards K. A. & Nimalendran M. (2007). "Corporate Bond Market Transparency": Liquidity Concentration, Information Efficiency and Competition. Retrieved on 24th April 2010.
Edwards k. A., Harris E. L. & Piwowar S. M. (2005). "Corporate Bond Market Transparency and Transaction Costs". Retrieved on 21st March 2010.
Gajjala S. (2006). "Pricing of Risk in the Indian Corporate Bond Market: Some Evidence". Journal of Accounting and Finance., Vol. 2, No. 2, Pg 95-104. Retrieved on 4th April 2010.
Goldstein M., Hotchkiss E. & Sirri E. (2005). "Transparency and Liquidity. A Contolled Experiment on Corporate Bonds". Babson College Working Paper. Retrieved on 15th April 2010.
Goyenko R., Subramanyam A. & Ukhov A. (2010). "The Term Structure of Bond Market Liquidity". Retrieved on 20th March 2010.
Hakansson H. N. (1999). "The Role of a Corporate Bond Market in an Economy and in Avoiding Crises". Retrieved on 4th April 2010.
Hameed F. (2006). "Fostering the Corporate Bond Market in Pakistan". Retrieved on 4th April 2010.
Harrison P. (2006). "The Impact of Market Liquidity in Times of Stress on Corporate Bond Issuance". Working Paper. Retrieved on 28th March 2010.
Hotchkiss E. & Jostova G. (2007). "Determinants of Corporate Bond Trading". A Comprehensive Analysis. Journal of Financial Market. Retrieved on 3rd April 2010.
Houweling P., Mentink A. & Vorst T. (2005). "Comparing Possible Proxies of Corporate Bond Liquidity". Journal of Banking & Finance, vol. 20, Pg 1331-1358. Retrieved on 3rd April 2010.
Houweling P., Mantink A. & Vorst T. (2003). "How to Measure Corporate Bond Liquidity?". Journal of Economic Research. Retrieved on 23rd March 2010.
Isshaq Z. & Bokpin A. G. (2009). "Corporate Bond Liquidity Management of Listed Firms in Ghana". Journal of Business, vol. 1, No. 2, Pg 189-198. Retrieved on 25th April 2010.
Kalimipalli M. & Warga A. (2008). "Bid Ask spread and volatility in the Corporate Bond Market". Journal of Banking and Finance. Retrieved on 1st April 2010.
Lin H., Wang J. & Wu C. (2008). "Liquidity Risk and the Cross Section of Expected Corporate Bond Returns". Retrieved on 1st April 2010.
Mahanti S., Nashikkar A., Subramanyam M., Chacko G. & Maliki G. (2008). "Latent Liquidity. A New Measure of Liquidity with an Application to Corporate Bonds". Journal of Financial Economics, vol. 88, Pg 272-298. Retrieved on 25th March 2010.
Mahanti S., Nashikkar A., Subramanyam M., Chacko G. & Maliki G. (2008). "Latent Liquidity. A New Measure of Liquidity with an Application to Corporate Bonds". Journal of Financial Economics, vol. 88, Pg 272-298. Retrieved on 25th March 2010.
Mohanty S. M. (2006). "Improving Liquidity in Government Bond Markets. What Can Be Done?". Working Paper of Bank Negara Malaysia. Retrieved on 30th March 2010.
Nielsen J. D., Utter F. P. & Lando D. (2009). "Coporate Bond Liquidity Before and After the Onset of the Subprime Crisis". Journal of Finance. Retrieved on 27th March 2010.
Nousheen Zafar, Syed Faiza Urooj & Tahir Khan Durrani. (2008). "Interest Rate Volatility and Stokc Return and Volatility". Journal of Economics, Finance and Adminstrative Sciences, vol. 14. Retrieved on 5th April 2010.
Shimizu S. (2008). "Corporate Bond Market of Korea, Malaysia and Thailand". Journal of International Economic Studies, vol. 22, No.22, Pg 71-86. Retrieved on 2nd of April 2010.
Tishchenko I, S. (2004). "Liquidity and Yield Spreads of Corporate Bonds". Doctoral Dissertation. Retrieved on 1st April 2010.
Wong A. & Muhammad Ibrahim. (2006). "The Corporate Bond Market in Malaysia". Working Paper of Bank Negara Malaysian. Retrieved on 1st April 2010.
Zambri Ahmad & Haslindar Ibrahim. (2002). "A Study of Performance of the KLSE Syariah Index". Journal of Management, vol. 1, No. 2, Pg 25-34. Retrieved on 29th March 2010.
Asian Bond Monitor Retrieved on 15th April 2010.
http://asianbondsonline.adb.org/
Malaysian Bond Hub. Retrieved on 4th April 2010.
http://bondinfo.bnm.gov.my/portal
