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The Price of Future Liquidity: Time-Varying Liquidity in the US Treasury Market

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  • Goldreich, David
  • Hanke, Bernd
  • Nath, Purnendu
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    Abstract

    This Paper examines the price differences between very liquid on-the-run US Treasury securities and less liquid off-the-run securities over the entire on/off cycle. Unlike previous studies, by comparing pairs of securities as their relative liquidity varies over time, we can disregard any cross-sectional differences between the securities. Also, since the liquidity of Treasury notes varies predictably over time we are able to distinguish between current liquidity and expected future liquidity. We show that the more liquid security is priced higher on average, but that this difference depends on the amount of expected future liquidity over its remaining lifetime rather than its current liquidity. We measure future liquidity using both quotes and trades. The liquidity measures include bid-ask spread, depth and trading activity. Examining a variety of liquidity measures enables us to evaluate their relative importance and to identify the liquidity proxies that most affect prices. Although all the measures are highly correlated with one another, we find that quoted bid-ask spread and quoted depth are more important than effective spread and trade size, respectively. Among measures of market activity, however, the number of trades and volume are more related to the liquidity premium than the number of quotes.

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    Bibliographic Info

    Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3900.

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    Date of creation: May 2003
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    Handle: RePEc:cpr:ceprdp:3900

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    Keywords: asset pricing; liquidity;

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    References

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    Cited by:
    1. Biais, Bruno & Renucci, Antoine & Saint-Paul, Gilles, 2007. "Liquidity and the cost of Funds and Integration of the Eurozone Treasury Bills Market," Economics Papers from University Paris Dauphine 123456789/2201, Paris Dauphine University.

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