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A heterogeneous agents equilibrium model for the term structure of bond market liquidity

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  • Schuster, Philipp
  • Trapp, Monika
  • Uhrig-Homburg, Marliese
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    Abstract

    We analyze the impact of market frictions on trading volume and liquidity premia of finite maturity assets when investors differ in their investment horizons. In equilibrium, short-horizon investors only invest in short-term assets and illiquidity spills over from short-term to long-term maturities. Our model predicts i) a hump-shaped relation between trading volume and maturity, ii) lower trading volumes of older compared to younger assets, iii) an increasing liquidity term structure when considering ask prices, and iv) a liquidity term structure from bid prices that is decreasing or U-shaped. Empirical tests for U.S. corporate bonds support our theoretical predictions. --

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    Bibliographic Info

    Paper provided by University of Cologne, Centre for Financial Research (CFR) in its series CFR Working Papers with number 13-05 [rev.].

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    Date of creation: 2013
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    Handle: RePEc:zbw:cfrwps:1305r

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    Related research

    Keywords: bond liquidity; term structure of liquidity premia; heterogeneous agents; aging effect; trading volume; equilibrium;

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    References

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    1. Jan ERICSSON & Olivier RENAULT, 2001. "Liquidity and Credit Risk," FAME Research Paper Series rp42, International Center for Financial Asset Management and Engineering.
    2. Francis A. Longstaff, 2002. "The Flight-to-Liquidity Premium in U.S. Treasury Bond Prices," NBER Working Papers 9312, National Bureau of Economic Research, Inc.
    3. Alexander, Gordon J. & Edwards, Amy K. & Ferri, Michael G., 2000. "The determinants of trading volume of high-yield corporate bonds," Journal of Financial Markets, Elsevier, vol. 3(2), pages 177-204, May.
    4. Merton, Robert C., 1973. "On the pricing of corporate debt: the risk structure of interest rates," Working papers 684-73., Massachusetts Institute of Technology (MIT), Sloan School of Management.
    5. Kempf, Alexander & Korn, Olaf & Uhrig-Homburg, Marliese, 2012. "The term structure of illiquidity premia," Journal of Banking & Finance, Elsevier, vol. 36(5), pages 1381-1391.
    6. Amy K. Edwards & Lawrence E. Harris & Michael S. Piwowar, 2007. "Corporate Bond Market Transaction Costs and Transparency," Journal of Finance, American Finance Association, vol. 62(3), pages 1421-1451, 06.
    7. Edwin J. Elton & T. Clifton Green, 1998. "Tax and Liquidity Effects in Pricing Government Bonds," Journal of Finance, American Finance Association, vol. 53(5), pages 1533-1562, October.
    8. Markus K. Brunnermeier & Lasse Heje Pedersen, 2009. "Market Liquidity and Funding Liquidity," Review of Financial Studies, Society for Financial Studies, vol. 22(6), pages 2201-2238, June.
    9. Jean-Sébastien Fontaine & René Garcia, 2009. "Bond Liquidity Premia," Working Papers 09-28, Bank of Canada.
    10. Mitchell A. Petersen, 2005. "Estimating Standard Errors in Finance Panel Data Sets: Comparing Approaches," NBER Working Papers 11280, National Bureau of Economic Research, Inc.
    11. Dimitri Vayanos & Tan Wang, 2004. "Search and endogenous concentration of liquidity in asset markets," LSE Research Online Documents on Economics 455, London School of Economics and Political Science, LSE Library.
    12. Wei Xiong & Zhiguo He, 2010. "Rollover Risk and Credit Risk," 2010 Meeting Papers 98, Society for Economic Dynamics.
    13. Amihud, Yakov & Mendelson, Haim, 1986. "Asset pricing and the bid-ask spread," Journal of Financial Economics, Elsevier, vol. 17(2), pages 223-249, December.
    14. Amihud, Yakov & Mendelson, Haim, 1991. " Liquidity, Maturity, and the Yields on U.S. Treasury Securities," Journal of Finance, American Finance Association, vol. 46(4), pages 1411-25, September.
    15. Duffie, Darrell & Singleton, Kenneth J, 1999. "Modeling Term Structures of Defaultable Bonds," Review of Financial Studies, Society for Financial Studies, vol. 12(4), pages 687-720.
    16. Goyenko, Ruslan & Subrahmanyam, Avanidhar & Ukhov, Andrey, 2011. "The Term Structure of Bond Market Liquidity and Its Implications for Expected Bond Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 46(01), pages 111-139, March.
    17. Robin Greenwood & Samuel Hanson & Jeremy C. Stein, 2008. "A Gap-Filling Theory of Corporate Debt Maturity Choice," NBER Working Papers 14087, National Bureau of Economic Research, Inc.
    18. Dick-Nielsen, Jens & Feldhütter, Peter & Lando, David, 2012. "Corporate bond liquidity before and after the onset of the subprime crisis," Journal of Financial Economics, Elsevier, vol. 103(3), pages 471-492.
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