Search results
1 – 10 of over 4000Haitao Li, Chunchi Wu and Jian Shi
The purpose of this paper is to estimate the effects of liquidity on corporate bond spreads.
Abstract
Purpose
The purpose of this paper is to estimate the effects of liquidity on corporate bond spreads.
Design/methodology/approach
Using a systematic liquidity factor extracted from the yield spreads between on- and off-the-run Treasury issues as a state variable, the authors jointly estimate the default and liquidity spreads from corporate bond prices.
Findings
The authors find that the liquidity factor is strongly related to conventional liquidity measures such as bid-ask spread, volume, order imbalance, and depth. Empirical evidence shows that the liquidity component of corporate bond yield spreads is sizable and increases with maturity and credit risk. On average the liquidity spread accounts for about 25 percent of the spread for investment-grade bonds and one-third of the spread for speculative-grade bonds.
Research limitations/implications
The results show that a significant part of corporate bond spreads are due to liquidity, which implies that it is not necessary for credit risk to explain the entire corporate bond spread.
Practical implications
The results show that returns from investments in corporate bonds represent compensations for bearing both credit and liquidity risks.
Originality/value
It is a novel approach to extract a liquidity factor from on- and off-the-run Treasury issues and use it to disentangle liquidity and credit spreads for corporate bonds.
Details
Keywords
Coupon and principal Separate Trading of Registered Interest and Principal Securities (STRIPS) maturing at the same date often trade at different yields. The paper aims to discuss…
Abstract
Purpose
Coupon and principal Separate Trading of Registered Interest and Principal Securities (STRIPS) maturing at the same date often trade at different yields. The paper aims to discuss this issue.
Design/methodology/approach
This paper analyzes for the first time the maturity structure of these differences for the US Treasury STRIPS market.
Findings
The paper surprisingly finds that short-term coupon STRIPS persistently trade at lower yields whereas long-term coupon STRIPS trade at higher yields compared to matched-maturity principal STRIPS.
Originality/value
An integrated analysis of Treasury STRIPS and the underlying notes market allows us to isolate two determinants: first, properties of the underlying notes that spill over to principal STRIPS, and second, the liquidity of coupon STRIPS measured by stripping activity and stripping volume.
Details
Keywords
This chapter focuses on examining how changes in the liquidity differential between nominal and TIPS yields influence optimal portfolio allocations in U.S. Treasury securities…
Abstract
This chapter focuses on examining how changes in the liquidity differential between nominal and TIPS yields influence optimal portfolio allocations in U.S. Treasury securities. Based on a nonparametric estimation technique and comparing the optimal allocation decisions of mean-variance and CRRA investor, when investment opportunities are time varying, I present evidence that liquidity risk premium is a significant risk-factor in a portfolio allocation context. In fact, I find that a conditional allocation strategy translates into improved in-sample and out-of-sample asset allocation and performance. The analysis of the portfolio allocation to U.S. government bonds is particularly important for central banks, specially in developing countries, given the fact that, collectively they have accumulate a large holdings of U.S. securities over the last 15 years.
Details
Keywords
The purpose of this study is to empirically investigate the impact of aggregate federal personal income tax evasion on the real interest rate yield on 10-year Treasury notes…
Abstract
Purpose
The purpose of this study is to empirically investigate the impact of aggregate federal personal income tax evasion on the real interest rate yield on 10-year Treasury notes, 20-year Treasury bonds and 30-year US Treasury bonds.
Design/methodology/approach
An open-economy loanable funds model is developed, with income tax evasion expressly included in the specification in the form of the AGI (adjusted gross income) gap and the ratio of unreported AGI to actual AGI, expressed as a per cent.
Findings
The empirical estimations reveal compelling evidence that income tax evasion thus measured acts to elevate the real interest rate yields on 10-year Treasury notes and both 20-year and 30-year Treasury bonds, raising the possibility of a tax evasion-induced form of “crowding out”.
Research limitations/implications
Ideally, tax evasion data for a longer time period would be very useful.
Practical implications
To the extent that greater federal personal income tax evasion yields a higher interest rate yield on 10-year, 20-year and 30-year Treasury debt issues, it is likely that the tax evasion will also elevate other interest rates in the economy.
Social implications
Higher interest rates resulting from tax evasion would likely slow-down macroeconomic growth and accelerate unemployment.
Originality/value
Neither the tax evasion literature nor the interest rate literature has ever considered the impact of tax evasion behavior on long-term interest rates.
Details
Keywords
Mohamed Ariff, Alireza Zarei and Ishaq Bhatti
This paper aims to report practice-relevant anomalous investment yield behavior of two types of bonds – Type A, the mainstream bond, and Type B, which is Sukuk – both having…
Abstract
Purpose
This paper aims to report practice-relevant anomalous investment yield behavior of two types of bonds – Type A, the mainstream bond, and Type B, which is Sukuk – both having similar cash-flow-relevant characteristics.
Design/methodology/approach
Bond valuation theory suggests that yields to investors of similarly rated bonds ought to be same. The authors collected time-series data on A and B bonds, all being coupon-paying bonds with similar rating and similar tenor as two matched samples traded in a bond exchange. To ensure the results are extended to different bond sectors, the data set was separated into treasury bonds as risk-free and corporate bonds as risky ones. The data set was further sub-divided into short-, medium- and long-tenor bonds. As the data straddle the Global Financial Crisis period, the authors use appropriate econometric method to control the possible effect from the crisis.
Findings
The average and median yields on Type A bond are significantly different from those of Type B. The test results show significant and systematic differences: treasury bonds of Type A returns yield lower than treasury bonds of Type B; the yields of corporate mainstream bonds (A) are higher than the yields of Sukuk (B). The authors observe these findings constitute a puzzle, being anomalous to theory.
Originality/value
This paper is original in that it is documenting significant differences in pricing of equivalent bonds. This has both theory and practice implications for fixed-income security market practices. The evidence is very strong to suggest that the identical types of bonds may have missing variable that contributes to the difference. Therefore, further research to identify the missing variable is necessary.
Details
Keywords
Qin Lei and Xuewu Wang
The purpose of this paper is to provide some rational perspectives for the flight‐to‐liquidity event rather than simply attributing it to the change in investor sentiment.
Abstract
Purpose
The purpose of this paper is to provide some rational perspectives for the flight‐to‐liquidity event rather than simply attributing it to the change in investor sentiment.
Design/methodology/approach
The paper builds a model to highlight the inherent difference in investors' investment horizon, and thus their sensitivity to changes in transaction costs in the stock and bond markets. When stock market deterioration results in higher trading costs, the existing marginal investor shifts wealth to bonds instead of remaining indifferent between stocks and bonds. At the new equilibrium, there is a higher fraction of bond ownership and a longer average investment horizon among stock holders. The paper then empirically tests the model predictions using data in the US stock and bond markets.
Findings
The authors find evidence strongly supporting this paper's theoretical predictions. Days with high stock illiquidity, high stock volatility and low stock return are associated with high yield spread in the bond market. This contemporaneous linkage between the stock market and the bond market is even stronger during periods with strong net outflows from stock mutual funds and strong net inflows to money market funds. The paper also demonstrates the existence of a maturity pattern that the predicted effects, especially the effects of stock illiquidity, are much stronger over shorter maturities.
Originality/value
The finding of this model that the investment horizon of the marginal investor (and thus the equilibrium price impact in the bond market) responds to changes in market conditions contributes to the theoretical debate on whether transaction costs matter. The flow evidence strengthens our understanding of the asset pricing implications of portfolio rebalancing decisions, and the maturity effect bolsters the case for flights to liquidity/quality due to heterogeneity in investment horizon without resorting to investor irrationality or behavioral attributes. In fact, it is arguably difficult to reconcile with a behavioral explanation.
Details
Keywords
ERCAN TIRTIROĞLU and DOĞAN TIRTIROĞLU
In an efficient market, where the participants form their expectations rationally, all potential changes induced by a predictable event are incorporated into the asset prices…
Abstract
In an efficient market, where the participants form their expectations rationally, all potential changes induced by a predictable event are incorporated into the asset prices before the uncertainty relating to the outcome of the event is resolved. This paper develops a methodology to test whether temporal prices of fixed income assets reflect market efficiency. The methodology developed employs the Fisher information measure, which is couched within the framework of a moving variance process. We empirically demonstrate the methodology for U.S. Treasury's first exercise, in three decades, of its option to call (on October 09, 1991) one of its outstanding callable bonds. Empirical results indicate a delayed market reaction.
Motivated by recent congressional interest in eradicating government sponsored enterprises (GSE), the purpose of this paper is to develop a framework to price the implicit…
Abstract
Purpose
Motivated by recent congressional interest in eradicating government sponsored enterprises (GSE), the purpose of this paper is to develop a framework to price the implicit government guarantee embedded in the bonds issued by the Farm Credit System.
Design/methodology/approach
The paper uses the Black‐Scholes model to extract the implied volatilities of the guarantee and then substitute into the model the volatility in historical land prices. The model is developed along the lines of Merton's bond pricing formulation of implicit calls and puts on bond yield risk and default.
Findings
Bottom line results show that the average bond yield for a 3M Farm Credit bond from January 13th 2009 to February 10th 2011 would be 0.3744 percent if the Farm Credit System had no GSE status, which is 13.62 bps higher than the actual bond yield. The difference between the hypothetical yield and the actual yield increases with increasing maturity and reaches its peak with 10Y bond where the difference between the hypothetical yield and the actual yield is 68.81 bps. The paper concludes that given the current state of the agricultural credit market in the USA that loss of GSE status and the implied guarantee of Farm Credit bonds would have a minimal effect on short term notes, with a more substantive increase in longer term yields.
Practical implications
The GSE status of the Farm Credit System is an important political issue. This paper provides first estimates of what impact might result from its loss of GSE status. The methods employed are consistent with current models of bond pricing and the results are of direct relevance to Farm Credit System regulators and congressional discussions.
Social implications
Farm credit is important, if the Farm Credit System loses its GSE status this might affect the competitive balance between commercial and system lenders.
Originality/value
This paper uses option price theory based upon the spread between farm credit bonds and treasury. The approach used requires daily data, but not all attributes of bonds are known. Nonetheless, the results show remarkable consistency for a problem that is largely understudied. There is a need for policy makers, including the US congress to understand the value of government guarantees whether implicit or explicit.
Details