Bridge over ocean
1 May 1996 Financial Analysts Journal Volume 52, Issue 3

Primary versus Secondary Pricing of High-Yield Bonds

  1. Martin S. Fridson, CFA
  2. Yan Gao

Previous research has found systematic underpricing of newly floated securities vis-à-vis secondary market levels. This conclusion is based on the observation that primary issues provide superior risk-adjusted returns in the period immediately following issuance. Those returns, however, are not known at the time of pricing. To gauge whether a new issue is offered at a premium or a concession to the secondary market, investors must use standard valuation benchmarks. In the case of high-yield bonds, an analysis based on agency ratings and yields to maturity indicates that new issues are priced richer than seasoned issues in some periods and cheaper in other periods. Using regression analysis, the authors model the magnitude of the premium or concession prevailing in a given period. The regressions explain 64 percent of the variance in the primary/secondary yield spread through proxies for supply, demand, and liquidity of the high-yield sector.

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