The Expected Illiquidity Premium: Evidence from Equity Index-Linked Bonds
AbstractWe examine a set of equity index-linked bonds that provide the same payoff as an investment in an equity index, but are relatively illiquid. We demonstrate that these securities sell at a discount relative to their underlying value and hence have higher expected returns. We show that this apparent mispricing can be attributed to the illiquidity of the bonds. Trading costs for equity-linked\ bonds, as measured by bid-ask spreads, are free of any asymmetric information or inventory holding cost component; hence the only illiquidity component left is clearing costs. This study shows that, even in the absence of asymmetric information and inventory holding costs, illiquidity depresses asset prices and therefore increases expected security returns. Using an ex ante measure of the expected return premium due to illiquidity, we link the time-series variation in the illiquidity premium to security-specific attributes related to their marketability. We show that liquidity risk has a systematic component, and relate this market-wide factor to a number of macroeconomic variables that have previously been shown to be related to illiquidity.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoArticle provided by Springer in its journal Review of Finance.
Volume (Year): 8 (2004)
Issue (Month): 1 ()
Contact details of provider:
Web page: http://springerlink.metapress.com/link.asp?id=111870
You can help add them by filling out this form.
CitEc Project, subscribe to its RSS feed for this item.
- David Goldreich & Bernd Hanke & Purnendu Nath, 2005. "The Price of Future Liquidity: Time-Varying Liquidity in the U.S. Treasury Market," Review of Finance, Springer, vol. 9(1), pages 1-32, 03.
- Andrew Ellul & Marco Pagano, 2006.
"IPO Underpricing and After-Market Liquidity,"
Review of Financial Studies,
Society for Financial Studies, vol. 19(2), pages 381-421.
- Houweling, Patrick & Mentink, Albert & Vorst, Ton, 2005.
"Comparing possible proxies of corporate bond liquidity,"
Journal of Banking & Finance,
Elsevier, vol. 29(6), pages 1331-1358, June.
- Houweling, P. & Mentink, A.A. & Vorst, A.C.F., 2003. "Comparing possible proxies of corporate bond liquidity," Econometric Institute Research Papers EI 2003-49, Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute.
- Goldreich, David & Hanke, Bernd & Nath, Purnendu, 2003. "The Price of Future Liquidity: Time-Varying Liquidity in the US Treasury Market," CEPR Discussion Papers 3900, C.E.P.R. Discussion Papers.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Guenther Eichhorn) or (Christopher F. Baum).
If references are entirely missing, you can add them using this form.