Treasury Liquidity, Funding Liquidity and Asset Returns

55 Pages Posted: 16 Mar 2012 Last revised: 17 Jul 2013

See all articles by Ruslan Goyenko

Ruslan Goyenko

McGill University - Desautels Faculty of Management

Date Written: July 16, 2013

Abstract

This paper links the illiquidity of US Treasuries to funding liquidity and shows that dealers’ financial constraints tighten after a positive shock to Treasury illiquidity. Consistent with the empirical properties of funding liquidity, illiquidity of Treasuries predicts changes in the TED spread and VIX index. Further, bond illiquidity is the only variable which consistently predicts the equity premium across sub-periods when controlling for all other common predictors. Moreover it is the only variable which survives the Goyal and Welch (2008, Review of Financial Studies) out-of-sample tests. Using it as a priced risk factor helps to explain cross-sectional returns of mutual funds. Controlling for stock market liquidity risk, funds with higher funding liquidity risk outperform funds with lower funding liquidity risk by 4.9% per annum. Fund inflows associated with lower funds’ liquidity constraints and higher funding liquidity risk predict superior performance.

Suggested Citation

Goyenko, Ruslan, Treasury Liquidity, Funding Liquidity and Asset Returns (July 16, 2013). Available at SSRN: https://ssrn.com/abstract=2023187 or http://dx.doi.org/10.2139/ssrn.2023187

Ruslan Goyenko (Contact Author)

McGill University - Desautels Faculty of Management ( email )

1001 Sherbrooke St. West
Montreal, Quebec H3A1G5 H3A 2M1
Canada

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