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Liquidity, Information Risk, and Asset Pricing: Evidence from the U.S. Government Bond MarketChunchi WuUniverstity at Buffalo Haitao LiUniversity of Michigan - Stephen M. Ross School of Business; Cheung Kong Graduate School of Business Yan HeIndiana University Southeast - School of Business Junbo WangCity University of HongKong AFA 2006 Boston Meetings Paper Abstract: We examine the effects of liquidity and information risks on expected returns of U.S. government bonds. Information risk is measured by probability of information-based trading (PIN) derived from the market microstructure model of Easley, Hvidkjaer, and O'Hara (2002). Liquidity risk is captured by sensitivity of individual bond returns to a market-wide liquidity measure along the line of Pastor and Stambaugh (2003). Controlling for systematic risks and bond characteristics, we find that both liquidity and information risks have a significantly positive effect on expected bond returns. Our findings suggest that incorporating microstructure factors into existing term structure models is a promising avenue for improving our understanding of bond price behavior.
Number of Pages in PDF File: 60 Keywords: Information risk, Liquidity risk, PIN, asset pricing, order imbalance JEL Classification: G12, M41 working papers seriesDate posted: March 23, 2005Suggested CitationContact Information
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