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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.

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.

This paper is based on a presentation made to the conference on Valuation in Emerging Markets at University of Virginia, May 28-30, 2002. We have benefited from discussions with and the comments of Chris Lundblad and Bob Brunner. *Corresponding author. E-mail address: cam.harvey@duke.edu

The market dynamics of technology stocks in the late 1990s have stimulated a growing body of theory that analyzes the joint effects of short-sales constraints and heterogeneous beliefs on stock prices and trading volume. This paper examines several implications of these theories using a unique data sample from a market with stringent short-sales constraints and perfectly segmented dual-class shares. The identical rights of the dual-class shares allow us to control for stock fundamentals. We find that trading caused by investors’ speculative motives can help explain a significant fraction of the price difference between the dual-class shares.

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.

We derive an equilibrium asset pricing model incorporating liquidity risk, derivatives, and short-selling due to hedging of non-traded risk. We show that illiquid assets can have lower expected returns if the short-sellers have more wealth, lower risk aversion or shorter horizon. The pricing of liquidity risk is different for derivatives than for positive-net-supply assets, and depends on the investors’ net non-traded risk exposure. We estimate this model for the credit default swap market using GMM. We find strong evidence for an expected liquidity premium earned by the credit protection seller. The effect of liquidity risk is significant but economically small. ∗A previous version of this paper was circulated under the title ’Liquidity and Liquidity Risk Premia in the CDS Market’. We are grateful to Moody’s KMV and Graeme Wood for providing the MKMV

In this paper we use data from China’s stock markets to analyze non-fundamental components in stock prices. During the period 1993-2000, several dozen Chinese firms offered two classes of shares: class A, which could only be held by domestic investors, and class B, which could only be traded by foreigners. Despite their identical rights, A-share prices were on average 400 % higher than the corresponding B shares. We use a model of investor overconfidence (Scheinkman and Xiong (2003)) that produces correlations among prices, turnover, and volatility, to explain this premium. By adopting a panel regression method, we find that the turnover rate of A shares is able to explain 20 % of the cross-sectional variation in A-B share premium. We also conduct various specification analyses, and examine the relation between float, turnover rate, and volatility.

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Swiss Doctoral Workshop in Finance for helpful comments. The views expressed herein are those of the authors and not necessarily those of the Swiss National Bank or UBS, which do not accept any responsibility for the contents and opinions expressed in this paper. Financial support by the Swiss National Science Foundation—National Centre of Competence in Research “Financial Valuation and Risk Management ” (NCCR FINRISK)—is gratefully acknowledged.