Hostname: page-component-89b8bd64d-j4x9h Total loading time: 0 Render date: 2026-05-13T05:27:33.387Z Has data issue: false hasContentIssue false
  • English
  • Français

The Term Structure of Bond Market Liquidity and Its Implications for Expected Bond Returns

Published online by Cambridge University Press:  10 November 2010

Ruslan Goyenko ,
Avanidhar Subrahmanyam  and
Andrey Ukhov
Ruslan Goyenko
Affiliation:
Desautels Faculty of Management, McGill University, 1001 Sherbrooke St. West, Montreal, Quebec H3A 1G5, Canada. ruslan.goyenko@mcgill.ca
Avanidhar Subrahmanyam
Affiliation:
Anderson School of Management, University of California at Los Angeles, C4.18 Entrepreneurs Hall, Los Angeles, CA 90095. subra@anderson.ucla.edu
Andrey Ukhov
Affiliation:
School of Hotel Administration, Cornell University, 465C Statler Hall, Ithaca, NY 14853. andrey.ukhov@gmail.com
Get access Rights & Permissions [Opens in a new window]

Abstract

Previous studies of Treasury market illiquidity span short time periods and focus on particular maturities. In contrast, we study the time series of illiquidity for different maturities over an extended period of time. We also compare time-series determinants of on-the-run and off-the-run illiquidity. Illiquidity increases and the difference between spreads of long- and short-term bonds significantly widens during recessions, suggesting a “flight to liquidity,” wherein investors shift into the more liquid short-term bonds during economic contractions. Macroeconomic variables such as inflation and federal funds rates forecast off-the-run illiquidity significantly but have only modest forecasting ability for on-the-run illiquidity. Bond returns across maturities are forecastable by off-the-run but not on-the-run bond illiquidity. Thus, off-the-run illiquidity, by reflecting macro shocks first, is the primary source of the liquidity premium in the Treasury market.

Information

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 46 , Issue 1 , February 2011 , pp. 111 - 139
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2011

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Article purchase

Temporarily unavailable

References

Acharya, V. V., and Pedersen, L. H.. “Asset Pricing with Liquidity Risk.” Journal of Financial Economics, 77 (2005), 375–410.CrossRefGoogle Scholar
Amihud, Y. “Illiquidity and Stock Returns: Cross-Section and Time-Series Effects.” Journal of Financial Markets, 5 (2002), 31–56.CrossRefGoogle Scholar
Amihud, Y., and Mendelson, H.. “Asset Pricing and the Bid-Ask Spread.” Journal of Financial Economics, 17 (1986), 223–249.CrossRefGoogle Scholar
Amihud, Y., and Mendelson, H.. “The Effect of Beta, Bid-Ask Spread, Residual Risk, and Size on Stock Returns.” Journal of Finance, 44 (1989), 479–486.Google Scholar
Amihud, Y., and Mendelson, H.. “Liquidity, Maturity, and the Yields on U.S. Treasury Securities.” Journal of Finance, 46 (1991), 1411–1425.CrossRefGoogle Scholar
Amihud, Y.; Mendelson, H.; and Pedersen, L.. “Liquidity and Asset Prices.” Foundations and Trends in Finance, 1 (2005), 269–364.CrossRefGoogle Scholar
Ang, A., and Piazzesi, M.. “A No-Arbitrage Vector Autoregression of Term Structure Dynamics with Macroeconomic and Latent Variables.” Journal of Monetary Economics, 50 (2003), 745–787.CrossRefGoogle Scholar
Balduzzi, P.; Elton, E. J.; and Green, T. C.. “Economic News and Bond Prices: Evidence from the U.S. Treasury Market.” Journal of Financial and Quantitative Analysis, 36 (2001), 523–543.CrossRefGoogle Scholar
Beber, A.; Brandt, M. W.; and Kavajecz, K. A.. “Flight-to-Quality or Flight-to-Liquidity? Evidence from the Euro-Area Bond Market.” Review of Financial Studies, 22 (2009), 925–957.CrossRefGoogle Scholar
Benston, G. J., and Hagerman, R. L.. “Determinants of Bid-Asked Spreads in the Over-the-Counter Market.” Journal of Financial Economics, 1 (1974), 353–364.CrossRefGoogle Scholar
Bliss, R. “Testing Term Structure Estimation Methods.” Advances in Futures and Options Research, 9 (1996), 197–231.Google Scholar
Boudoukh, J., and Whitelaw, R. F.. “Liquidity as a Choice Variable: A Lesson from the Japanese Government Bond Market.” Review of Financial Studies, 6 (1993), 265–292.CrossRefGoogle Scholar
Brandt, M. W., and Kavajecz, K. A.. “Price Discovery in the U.S. Treasury Market: The Impact of Order Flow and Liquidity on the Yield Curve.” Journal of Finance, 59 (2004), 2623–2654.CrossRefGoogle Scholar
Brennan, M. J., and Subrahmanyam, A.. “Market Microstructure and Asset Pricing: On the Compensation for Illiquidity in Stock Returns.” Journal of Financial Economics, 41 (1996), 441–464.CrossRefGoogle Scholar
Brunnermeier, M. K., and Pedersen, L. H.. “Market Liquidity and Funding Liquidity.” Review of Financial Studies, 22 (2009), 2201–2238.CrossRefGoogle Scholar
Campbell, J. Y., and Ammer, J.. “What Moves Stock and Bond Markets? A Variance Decomposition for Long-Term Asset Returns.” Journal of Finance, 48 (1993), 3–37.Google Scholar
Chordia, T.; Roll, R.; and Subrahmanyam, A.. “Market Liquidity and Trading Activity.” Journal of Finance, 56 (2001), 501–530.CrossRefGoogle Scholar
Chordia, T.; Sarkar, A.; and Subrahmanyam, A.. “Common Determinants of Bond and Stock Market Liquidity: The Impact of Financial Crises, Monetary Policy, and Mutual Fund Flows.” Working Paper, University of California at Los Angeles (2002).Google Scholar
Chordia, T.; Sarkar, A.; and Subrahmanyam, A.. “An Empirical Analysis of Stock and Bond Market Liquidity.” Review of Financial Studies, 18 (2005), 85–129.CrossRefGoogle Scholar
Duffie, D.; Gârleanu, N.; and Pedersen, L. H.. “Valuation in Over-the-Counter Markets.” Review of Financial Studies, 20 (2007), 1865–1900.CrossRefGoogle Scholar
Dumas, B. “A Test of the International CAPM Using Business Cycles Indicators as Instrumental Variables.” In The Internationalization of Equity Markets, Frankel, J. A., ed. Chicago, IL: University of Chicago Press (1994)Google Scholar
Fama, E. F., and French, K. R.. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics, 33 (1993), 3–56.CrossRefGoogle Scholar
Fleming, M. “Measuring Treasury Market Liquidity.” Federal Reserve Bank of New York Economic Policy Review, 9 (2003), 83–108.Google Scholar
Fleming, M. J., and Garbade, K. D.. “When the Back Office Moved to the Front Burner: Settlement Fails in the Treasury Market After 9/11.” Economic Policy Review, 8 (2002), 35–57.Google Scholar
Fleming, M. J., and Remolona, E. M.. “What Moves the Bond Market?” Economic Policy Review, 3 (1997), 31–50.Google Scholar
Fleming, M. J., and Remolona, E. M.. “Price Formation and Liquidity in the U.S. Treasury Market: The Response to Public Information.” Journal of Finance, 54 (1999), 1901–1915.CrossRefGoogle Scholar
Garbade, K. D. “The Emergence of ‘Regular and Predictable’ as a Treasury Debt Management Strategy.” Economic Policy Review, 13 (2007), 53–71.Google Scholar
Goldreich, D.; Hanke, B.; and Nath, P.. “The Price of Future Liquidity: Time-Varying Liquidity in the U.S. Treasury Market.” Review of Finance, 9 (2005), 1–32.CrossRefGoogle Scholar
Goyenko, R. Y., and Ukhov, A. D.. “Stock and Bond Market Liquidity: A Long-Run Empirical Analysis.” Journal of Financial and Quantitative Analysis, 44 (2009), 189–212.CrossRefGoogle Scholar
Green, T. C. “Economic News and the Impact of Trading on Bond Prices.” Journal of Finance, 59 (2004), 1201–1233.CrossRefGoogle Scholar
Gurkaynak, R. S.; Sack, B.; and Wright, J. H.. “The U.S. Treasury Yield Curve: 1961 to the Present.” Journal of Monetary Economics, 54 (2007), 2291–2304.CrossRefGoogle Scholar
Ho, T. S. Y., and Stoll, H. R.. “The Dynamics of Dealer Markets under Competition.” Journal of Finance, 38 (1983), 1053–1074.CrossRefGoogle Scholar
Huang, R. D.; Cai, J.; and Wang, X.. “Information-Based Trading in the Treasury Note Inter-Dealer Broker Market.” Journal of Financial Intermediation, 11 (2002), 269–296.CrossRefGoogle Scholar
Jones, C. M. “A Century of Stock Market Liquidity and Trading Costs.” Working Paper, Columbia University (2002).CrossRefGoogle Scholar
Kamara, A. “Liquidity, Taxes, and Short-Term Treasury Yields.” Journal of Financial and Quantitative Analysis, 29 (1994), 403–417.CrossRefGoogle Scholar
Krishnamurthy, A. “The Bond/Old-Bond Spread.” Journal of Financial Economics, 66 (2002), 463–506.CrossRefGoogle Scholar
Longstaff, F. A. “The Flight-to-Liquidity Premium in U.S. Treasury Bond Prices.” Journal of Business, 77 (2004), 511–526.CrossRefGoogle Scholar
Merton, R. C. “Optimal Consumption and Portfolio Rules in a Continuous-Time Model.” Journal of Economic Theory, 3 (1971), 373–413.CrossRefGoogle Scholar
Miller, G. H. Jr.; Mitchell, K.; and Hoxworth, D.. “The U.S. Economy and Monetary Policy in 1983.” Economic Review, Federal Reserve Bank of Kansas City, December (1983), 3–21.Google Scholar
O’Hara, M., and Oldfield, G. S.. “The Microeconomics of Market Making.” Journal of Financial and Quantitative Analysis, 21 (1986), 361–376.CrossRefGoogle Scholar
Pastor, L., and Stambaugh, R. F.. “Liquidity Risk and Expected Stock Returns.” Journal of Political Economy, 111 (2003), 642–685.CrossRefGoogle Scholar
Sack, B., and Elsasser, R.. “Treasury Inflation-Indexed Debt: A Review of the U.S. Experience.” Economic Policy Review, 10 (2004), 47–63.Google Scholar
Shiller, R. J. Market Volatility. Cambridge, MA: MIT Press (1989).Google Scholar
Shiller, R. J., and Perron, P.. “Testing the Random Walk Hypothesis: Power vs. Frequency of Observation.” Economics Letters, 18 (1985), 381–386.CrossRefGoogle Scholar
Thorbecke, W. “On Stock Market Returns and Monetary Policy.” Journal of Finance, 52 (1997), 635–654.CrossRefGoogle Scholar
Warga, A. “Bond Returns, Liquidity, and Missing Data.” Journal of Financial and Quantitative Analysis, 27 (1992), 605–617.CrossRefGoogle Scholar