Liquidity, Information Risk, and Asset Pricing: Evidence from the U.S. Government Bond Market
SUNY at Buffalo - School of Management
University of Michigan - Stephen M. Ross School of Business; Cheung Kong Graduate School of Business; Cheung Kong Graduate School of Business
Indiana University Southeast - School of Business
City University of HongKong
AFA 2006 Boston Meetings Paper
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
Date posted: March 23, 2005
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