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wish to thank Andre Haris, Lozan Bakayatov, and Davron Yakubov for their excellent data collection efforts. In addition, we thank the financial assistance of the Social Sciences and Humanities Research Council of Canada. All errors remain the responsibility of the authors. Corporate Yield Spreads and Bond Liquidity We examine whether liquidity is priced in corporate yield spreads. Using a battery of liquidity measures covering over 4000 corporate bonds and spanning investment grade and speculative categories, we find that more illiquid bonds earn higher yield spreads; and that an improvement of liquidity causes a significant reduction in yield spreads. These results hold after controlling for common bond-specific, firm-specific, and macroeconomic variables, and are robust to issuers ’ fixed effect and potential endogeneity bias. Our finding mitigates the concern in the default risk literature that neither the level nor the dynamic of yield spreads can be fully explained by default risk determinants, and suggests that liquidity plays an important role in corporate bond valuation.

Abstract: We analyze cross-sectional and time series information from fortyseven equity markets around the world, to consider whether short–sales restrictions affect the efficiency of the market, and the distributional characteristics of returns to individual stocks and market indices. Using the approach developed in Mørck et al. (2000) we find significantly more crosssectional variation in equity returns in markets where short selling is feasible and practiced, controlling for a host of other factors. This evidence is consistent with more efficient price discovery at the individual security level. A common conjecture by regulators is that short–sales restrictions can reduce the relative severity of a market panic. We test this conjecture by examining the skewness of market returns. We find that in markets where short selling is either prohibited or not practiced, individual stock returns display significantly less negative skewness. However, at the market level, where regulators might expect short– sales restrictions to reduce the severity of broad declines, short sales restrictions appear to make no difference. We thank Gerard Goetz for excellent research assistance, and to Frank Fabozzi for considerable help in obtaining

This paper examines the illiquidity of corporate bonds and its asset-pricing implications. Using transaction-level data from 2003 through 2009, we show that the illiquidity in corporate bonds is substantial, significantly greater than what can be explained by bidask spreads. We establish a strong link between bond illiquidity and bond prices, both in aggregate and in the cross-section. In aggregate, changes in the market level illiquidity explain a substantial part of the time variation in yield spreads of high-rated (AAA through A) bonds, over-shadowing the credit risk component. In the cross-section, the bond-level illiquidity measure explains individual bond yield spreads with large economic significance.

I introduce bankruptcy into a complete markets model with a continuum of ex ante identical agents who have power utility. Shares in a Lucas tree serve as collateral. Bankruptcy gives rise to a second risk factor in addition to aggregate consumption growth risk. This liquidity risk is created by binding solvency constraints. The risk is measured by one moment of the wealth distribution, which multiplies the standard Breeden-Lucas stochastic discount factor. The economy is said to experience a negative liquidity shock when this growth rate is high, a large fraction of agents faces severely binding solvency constraints and the trading volume is low in financial markets. The adjustment to the Breeden-Lucas stochastic discount factor induces time variation in equity, bond and currency risk premia that is consistent with the data.

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I describe asset price dynamics caused by the slow movement of investment capital to trading opportunities. The pattern of price responses to supply or demand shocks typically involves a sharp reaction to the shock and a subsequent and more extended reversal. The amplitude of the immediate price impact and the pattern of the subsequent recovery can reflect institutional impediments to immediate trade, such as search costs for trading counterparties or time to raise capital by intermediaries. I discuss special impediments to capital formation during the recent financial crisis that caused asset price distortions, which subsided afterward. After presenting examples of price reactions to supply shocks in normal market settings, I offer a simple illustrative model of price dynamics associated with slow-moving capital due to the presence of inattentive investors. I ADDRESS THE IMPLICATIONS for asset price dynamics of the apparent slow movement of investment capital to trading opportunities. The arrival of new capital to an investment opportunity can be delayed by fractions of a second in some

We study the economic sources of stock–bond return comovements and their time variation using a dynamic factor model. We identify the economic factors employing a semistruc-tural regime-switching model for state variables such as interest rates, inflation, the output gap, and cash flow growth. We also view risk aversion, uncertainty about inflation and output, and liquidity proxies as additional potential factors. We find that macroeconomic fundamentals contribute little to explaining stock and bond return correlations but that other factors, especially liquidity proxies, play a more important role. The macro factors are still important in fitting bond return volatility, whereas the “variance premium ” is criti-cal in explaining stock return volatility. However, the factor model primarily fails in fitting covariances. (JEL G11, G12, G14, E43, E44) Stock and bond returns in the United States display an average correlation of about 19 % during the post-1968 period. Shiller and Beltratti (1992) un-derestimate the empirical correlation using a present value with constant dis-count rates, whereas Bekaert, Engstrom, and Grenadier (2005) overestimate it in a consumption-based asset pricing model with stochastic risk aversion. Yet,

Abstract This paper explores the role of liquidity risk in the pricing of corporate bonds. We show that liquidity risk is a priced factor for the expected returns on corporate bonds. The exposures of corporate bond returns to fluctuations in treasury bond liquidity and equity market liquidity help to explain the credit spread puzzle. In terms of expected returns, the total estimated liquidity risk premium is around 0.45% for US long-maturity investment grade bonds. For speculative grade bonds, which have higher exposures to the liquidity factors, the liquidity risk premium is around 1%. We find very similar evidence for the liquidity risk exposure of corporate bonds using a sample of European corporate bond prices. * Liquidity Risk Premia in Corporate Bond Markets Abstract This paper explores the role of liquidity risk in the pricing of corporate bonds. We show that liquidity risk is a priced factor for the expected returns on corporate bonds. The exposures of corporate bond returns to fluctuations in treasury bond liquidity and equity market liquidity help to explain the credit spread puzzle. In terms of expected returns, the total estimated liquidity risk premium is around 0.45% for US long-maturity investment grade bonds. For speculative grade bonds, which have higher exposures to the liquidity factors, the liquidity risk premium is around 1%. We find very similar evidence for the liquidity risk exposure of corporate bonds using a sample of European corporate bond prices.

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