We develop a structural credit-risk model with information asymmetry between the current bondholders and outside bond investors. We show that both the amount of informed trading and the informational liquidity discount increase in the credit risk of an underlying firm. We calibrate the model to match the bond turnover ratios across different rating classes. Our calibrated model implies that the informational friction accounts for 0.59% to 1.86% of the yield spreads for investment-grade bonds and 3.46% to 10.91% for high-yield bonds. We show that liquidity injection into the high-yield bond market may hurt liquidity by inducing more informed trading.

Keywords: corporate bonds, information asymmetry, liquidity, yield-spread decomposition

JEL Classifications: G33, G14, G32​