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Explaining the On-The-Run Puzzle with Corporate Bonds

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  • Anthony Jerome Anderson

    (Department of Accounting, Howard University, School of Business, 2600 6th St., NW, Suite 348, Washington, DC 20059, USA)

  • Michael Stuart Long

    (Rutgers Business School – Newark & New Brunswick, 1 Washington Park Place, Newark, NJ 07102, USA)

Abstract

The on-the-run phenomenon is regularly found in the bond markets. It refers to the phenomenon of the yield difference observed when a new bond issue comes to market from the same issuer and gets a better price (lower yield given equivalent duration) from the market than the older issue. This paper proposes and tests a liquidity model to explain phenomenon introducing entropy as our liquidity measure. The yield differential results from the illiquidity cost of the older issue that has increased as a result of progressing through stages, which typically occur in an entropy process. We find that a model employing an entropy measure largely explains the on-the-run phenomenon, by accounting for over three-quarters of the liquidity differential for on-the-run corporate bonds.

Suggested Citation

  • Anthony Jerome Anderson & Michael Stuart Long, 2017. "Explaining the On-The-Run Puzzle with Corporate Bonds," Review of Pacific Basin Financial Markets and Policies (RPBFMP), World Scientific Publishing Co. Pte. Ltd., vol. 20(02), pages 1-36, June.
    • Handle: RePEc:wsi:rpbfmp:v:20:y:2017:i:02:n:s0219091517500084
    DOI: 10.1142/S0219091517500084
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