Spread determinants

External question — Quantitative Finance Stack Exchange Author: Nenne Original post: https://quant.stackexchange.com/questions/54899 License: CC BY-SA 4.0 — https://creativecommons.org/licenses/by-sa/4.0/ Adaptation: HTML converted to plain text; contact email addresses removed. Knowing that bond A is more liquid that bond B, i.e higher volumes are traded on bond A, does this information have any impact on the spread? Can we say that the large volumes traded on A will increase the spread between A and B? Does this work the same as online trading, e.g on Forex market, where EUR/USD will have the lowest spread, due to the greatest liquidity? I'm very confused about that, and hope someone can help.

External answer — Quantitative Finance Stack Exchange Author: Dimitri Vulis Original post: https://quant.stackexchange.com/a/54901 License: CC BY-SA 4.0 — https://creativecommons.org/licenses/by-sa/4.0/ Adaptation: HTML converted to plain text; contact email addresses removed. If a corporate bond is less liquid / harder to source (e.g. it was issued years ago and most people who hold it now intend to hold it to maturity; or there just isn't a lot outstanding) then, ceteris paribus, the bid-ask spread is likely to be wider than comparable bonds; the spread on top of treasury yield is usually wider (to compensate for the risk of holding an asset that might be hard to sell if desired). The volume (on Trace) is the best first approximation of how hard it is to source some bond, but still not perfect. It may turn out to be hard to find a bond that recently traded a lot and vice versa. For this reason, the relationship between volume and bid-ask spread isn't as clear.