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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
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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.

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

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