Stock and Bond Market Liquidity: A Long-Run Empirical Analysis

Abstract

This paper establishes liquidity linkage between stock and Treasury bond markets. There is a lead-lag relationship between illiquidity of the two markets and bidirectional Granger causality. The effect of stock illiquidity on bond illiquidity is consistent with flight-toquality or flight-to-liquidity episodes. Monetary policy impacts illiquidity. The evidence indicates that bond illiquidity acts as a channel through which monetary policy shocks are transferred into the stock market. These effects are observed across illiquidity of bonds of different maturities and are especially pronounced for illiquidity of short-term maturities. The paper provides evidence of illiquidity integration between stock and bond markets.

Illiquidity Transmission in a Three-Country Framework: A Conditional Approach

“…Positive productivity shocks are related to higher economic activity and can induce investors to rebalance their portfolios to more risky assets which again results in a lower bond market liquidity. Both effects are empirically validated by Goyenko and Ukhov (2009). They find that innovations of the growth rate of the consumer price index (CPI) significantly and positively affect short-and long-term bond illiquidity and a shock to the growth rate of industrial production (IP) slightly increases bond illiquidity in all maturities with some delay.…”

“…As a consequence, there is a lower demand and thus liquidity on the bond market decreases. Moreover, as Goyenko and Ukhov (2009) point out, surprises in inflation increase inventory holding and order processing costs and thus influence liquidity. Positive productivity shocks are related to higher economic activity and can induce investors to rebalance their portfolios to more risky assets which again results in a lower bond market liquidity.…”

“…18 CPI does not have the expected sign in the univariate regression. Findings are mixed in the literature (e.g., Goyenko and Ukhov 2009;Goyenko et al 2011) depending on the maturity and whether a bond is on-/off-the-run. Using realized CPI instead of forecasts results in insignificant coefficients.…”

“…The relation between liquidity of different U.S. markets is studied as well. Chordia et al (2005) and Goyenko and Ukhov (2009) examine the linkage between the stock and bond market using a vector autoregression model and Pu (2009) finds a strong commonality in liquidity between the credit default swap (CDS) and U.S. corporate bond market. In contrast, our focus is on international spillovers which reveals interesting insights.…”

Does the Euro affect the dynamic relation between stock market liquidity and the business cycle?

“…Following market microstructure literature, we consider three liquidity measures: relative quoted bid-ask spreads (RS), the Amihud illiquidity ratio (ILLIQ) (Amihud (2002)), and the trading velocity (VEL) of each country's stock exchange (from the World Federation of Exchanges). Goyenko & Ukhov (2009) show that these liquidity measures (ILLIQ and RS) effectively capture price impact and spread cost (see also Goyenko, Holden, & Trzcinka (2009);Hasbrouck (2009)). So, when the RS and ILLIQ measures have high value, it implies that market liquidity is low and it is costly to execute trade.…”