The Term Structure of Bond Market Liquidity and Its Implications for Expected Bond Returns
MetadataShow full item record
Goyenko, Ruslan; Subrahmanyam, Avanidhar; Ukhov, Andrey
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.
liquidity; bond markets; returns; off-the-run illiquidity; on-the-run illiquidity
Required Publisher Statement: © Cambridge University Press. Reprint with permission. All rights reserved.