We examine the relative yields of Treasuries and municipals using a generalized model that includes liquidity as a state factor. Using a unique transaction dataset, we are able to estimate the liquidity risk of municipals and its effect on bond yields. We find that a substantial portion of the...

This article explores the expectations of the credit market by developing a parsimonious default swap model, which is versatile enough to disentangle default probability from the expected recovery rate, accommodate counterparty default risk, and allow flexible correlation between state...