Kenneth R. Szulczyk
Corporate Bonds U.S. Government SecuritiesFigure 2. Impact of liquidity on the bond markets
Information Costs and Bond Prices
Information costs influence the bond prices and interest rates. If investors need time and
money to acquire information on securities, then they pay a greater information cost. We include
these costs in the bond’s market price and interest rate, and they raise the cost of borrowing. For
example, investors know both U.S. government securities and corporate bonds from large
corporations well, and the securities have the lowest information costs. On the other hand, the
information costs for new and small companies are high, and therefore, these companies pay
greater interest rates when they borrow funds.
We can use the demand and supply analysis to create two markets for the high and low-
information-cost bond markets. Both markets start with the same level of information, and
consequently, the bond prices and interest rates are identical. We depict the bond markets in
Figure 3. The equilibrium bond prices are identical for both markets and equal P* and the
interest rates would be equal.
Investors pay a greater cost to acquire information for the high information cost bonds.
Thus, investors are attracted to the low-information cost bonds, boosting their demand for low-
information cost bonds, increasing the market price and decreasing market interest rate. High-
information cost bonds are not as attractive as an investment, so investors buy fewer bonds,
reducing bond prices and raising interest rates. Therefore, low-information-cost bonds pay a
lower interest rate.