Explaining the On-the-Run Puzzle
Anthony J. Anderson
Howard University - School of Business
Michael S. Long Sr.
Rutgers University at Newark
January 14, 2014
The on-the-run phenomenon is regularly found in the bond markets. The on-the-run phenomenon is 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 using 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 two-thirds of the liquidity differential for on-the-run corporate bonds.
Number of Pages in PDF File: 43
Keywords: Bonds, liquity, valuation
JEL Classification: G19
Date posted: February 5, 2014
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