A heterogeneous agents equilibrium model for the term structure of bond market liquidity

We analyze the impact of market frictions on trading volume and liquidity premia of finite maturity assets when investors differ in their investment horizons. In equilibrium, short-horizon investors only invest in short-term assets and illiquidity spills over from short-term to long-term maturities. Our model predicts i) a hump-shaped relation between trading volume and maturity, ii) lower trading volumes of older compared to younger assets, iii) an increasing liquidity term structure when considering ask prices, and iv) a liquidity term structure from bid prices that is decreasing or U-shaped. Empirical tests for U.S. corporate bonds support our theoretical predictions.