Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/87377
Authors: 
Bouwman, Kees E.
Sojli, Elvira
Tham, Wing Wah
Year of Publication: 
2012
Series/Report no.: 
Tinbergen Institute Discussion Paper 12-140/IV/DSF46
Abstract: 
We assess the effect of aggregate stock market illiquidity on U.S. Treasury bond risk premia. We find that the stock market illiquidity variable adds to the well established Cochrane-Piazzesi and Ludvigson-Ng factors. It explains 10%, 9%, 7%, and 7% of the one-year-ahead variation in the excess return for two-, three-, four-, and five-year bonds respectively and increases the adjusted R2 by 3-6% across all maturities over Cochrane and Piazzesi (2005) and Ludvigson and Ng (2009) factors. The effects are highly statistically and economically significant both in and out of sample. We find that our result is robust to and is not driven by information from open interest in the futures market, long-run inflation expectations, dispersion in beliefs, and funding liquidity. We argue that stock market illiquidity is a timely variable that is related to right-to-quality episodes and might contain information about expected future business conditions through funding liquidity and investment channels.
Subjects: 
Market liquidity
Bond risk premia
Flight-to-quality
JEL: 
G10
G20
G14
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

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