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Working Paper
The Liquidity Effects of Official Bond Market Intervention
To "ensure depth and liquidity," the European Central Bank in 2010 and 2011 repeatedly intervened in sovereign debt markets through its Securities Markets Programme. These purchases provide a unique natural experiment for testing the effects of large-scale asset purchases on risk premia arising from liquidity concerns. To explore how official intervention influences liquidity premia, we develop a search-based asset-pricing model. Consistent with our model's predictions, we find statistically and economically significant stock and flow effects on sovereign bonds' liquidity premia in ...
Working Paper
Accounting for Low Long-Term Interest Rates: Evidence from Canada
In recent decades, long-term interest rates around the world have fallen to historic lows. We examine this decline using a dynamic term structure model of Canadian nominal and real yields with adjustments for term, liquidity, and inflation risk premiums. Canada provides a useful case study that has been little examined despite its established indexed debt market, negligible distortions from monetary quantitative easing or the zero lower bound, and no sovereign credit risk. We find that since 2000, the steady-state real interest rate has fallen by more than 2 percentage points, long-term ...
Working Paper
Accounting for Low Long-Term Interest Rates: Evidence from Canada
In recent decades, long-term interest rates around the world have fallen to historic lows. We examine this decline using a dynamic term structure model of Canadian nominal and real yields with adjustments for term, liquidity, and inflation risk premiums. Canada provides a useful case study that has been little examined despite its established indexed debt market, negligible distortions from monetary quantitative easing or the zero lower bound, and no sovereign credit risk. We find that since 2000, the steady-state real interest rate has fallen by more than 2 percentage points, long-term ...
Working Paper
Inflation Expectations and Risk Premia in Emerging Bond Markets: Evidence from Mexico
To study inflation expectations and associated risk premia in emerging bond markets, thispaper provides estimates for Mexico based on an arbitrage-free dynamic term structuremodel of nominal and real bond prices that accounts for their liquidity risk. In addition todocumenting the existence of large and time-varying liquidity premia in nominal and realbond prices that are only weakly correlated, the results indicate that long-term inflationexpectations in Mexico are well anchored close to the inflation target of the Bank ofMexico. Furthermore, Mexican inflation risk premia are larger and more ...
Working Paper
Modeling Money Market Spreads: What Do We Learn about Refinancing Risk?
We quantify the effect of refinancing risk on euro area money market spreads, a major factor driving spreads during the financing crisis. With the advent of the crisis, market participants' perception of their ability to refinance over a given period of time changed radically. As a result, borrowers preferred to obtain funding for longer tenors and lenders were willing to provide funding for shorter tenors. This discrepancy resulted in a need to refinance more frequently in order to borrow over a given horizon, thus increasing refinancing risk. We measure refinancing risk by quantifying the ...
Report
Inflation Expectations and Risk Premia in Emerging Bond Markets: Evidence from Mexico
To study inflation expectations and associated risk premia in emerging bond markets, this paper provides estimates for Mexico based on an arbitrage-free dynamic term structure model of nominal and real bond prices that accounts for their liquidity risk. In addition to documenting the existence of large and time-varying liquidity premia in nominal and real bond prices that are only weakly correlated, the results indicate that long-term inflation expectations in Mexico are well anchored close to the inflation target of the Bank of Mexico. Furthermore, Mexican inflation risk premia are larger ...
Discussion Paper
How Liquidity Standards Can Improve Lending of Last Resort Policies
Prior to the Great Recession, the focus of bank regulation was on bank capital with little consensus about the need for liquidity regulation. This view was in contrast with an existing body of academic research that pointed to inefficiencies in environments with strictly private provision of liquidity, via either interbank markets or credit line agreements. In spite of theoretical results pointing to the possible benefits of liquidity regulation for reducing fire sales in crises or the risk of panics due to coordination failures, a common view was that its costs might exceed its benefits, ...
Report
Decomposing real and nominal yield curves
We present an affine term structure model for the joint pricing of Treasury Inflation-Protected Securities (TIPS) and Treasury yield curves that adjusts for TIPS? relative illiquidity. Our estimation using linear regressions is computationally very fast and can accommodate unspanned factors. The baseline specification with six principal components extracted from Treasury and TIPS yields, in combination with a liquidity factor, generates negligibly small pricing errors for both real and nominal yields. Model-implied expected inflation provides a better prediction of actual inflation than ...
Working Paper
When do low-frequency measures really measure transaction costs?
We compare popular measures of transaction costs based on daily data with their high-frequency data-based counterparts. We find that for U.S. equities and major foreign exchange rates, (i) the measures based on daily data are highly upward biased and imprecise; (ii) the bias is a function of volatility; and (iii) it is primarily volatility that drives the dynamics of these liquidity proxies both in the cross section as well as over time. We corroborate our results in carefully designed simulations and show that such distortions arise when the true transaction costs are small relative to ...
Discussion Paper
Has Liquidity Risk in the Treasury and Equity Markets Increased?
Market participants have argued that market liquidity has deteriorated since the financial crisis. However, inspection of common metrics such as bid-ask spreads, market depth, and price impact do not show pronounced reductions in liquidity compared with precrisis levels. In this post, we argue that recent changes in liquidity conditions may best be described in terms of heightened liquidity risk, as opposed to general declines in liquidity levels. We propose a measure that shows liquidity risk has risen in equity and Treasury markets and discuss some factors behind the increase.