57 Pages Posted: 20 Mar 2012 Last revised: 5 Dec 2013
Date Written: November 11, 2011
In this paper, we study the link between government bonds and cross-section of stocks. We provide new evidence that links the stock market liquidity to sovereign bond risk premia. We find that the stock market illiquidity variable adds to the well-established Cochrane-Piazzesi and Ludvigson-Ng factors. It explains 10%, 9%, 7%, and 7% of the one-year-ahead variation in the excess return for two-, three-, four-, and five-year bonds respectively and increases the adjusted R2 by 3-6% across all maturities over Cochrane and Piazzesi (2005) and Ludvigson and Ng (2009) factors. The effects are highly statistically and economically significant both in and out of sample. We find that our result is robust to and is not driven by information from open interest in the futures market, long-run inflation expectations, and dispersion in beliefs. We argue that stock market illiquidity is a timely variable that is associated with the state of funding liquidity.
Keywords: Market liquidity, Bond risk premia, Flight-to-quality
JEL Classification: G10, G20, G14
Suggested Citation: Suggested Citation
Bouwman, Kees E. and Sojli, Elvira and Tham, Wing Wah, Stock Market Illiquidity, Funding Liquidity, and Bond Risk Premia (November 11, 2011). Asian Finance Association (AsFA) 2013 Conference; 26th Australasian Finance and Banking Conference 2013. Available at SSRN: https://ssrn.com/abstract=2019094 or http://dx.doi.org/10.2139/ssrn.2019094
By Andrew Ang