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Many faces of liquidity and asset pricing: evidence from the U.S. treasury securities market



Publishing details

IFA Working Paper

Publication Year



This paper suggests a number of new tests to investigate the liquidity effects on asset pricing and illuminates the connection between a number of market imperfections and liquidity. Specifically, we test the illiquidity premium hypothesis by comparing different U.S. Treasury securities that mature on the same day. We propose a new robust test, where we match notes maturing on the same day. Using three years of intraday interdealer data, we reject the hypothesis since we found no discrepancy in notes pricing even though their liquidity is substantially different. Previous studies found strong evidence in favor of the hypothesis by matching bills and notes. Replicating their results, we confirm the empirical findings. We argue, however, that matching bills and notes do not provide the coherent test of the hypothesis. In particular, we identify cross-sectional variation in pricing difference that cannot be supported by the hypothesis. We also show, contrary to the illiquidity premium explanation, that the discrepancy is smaller for on-the-run bills when the difference in liquidity between bills and notes is very large. We hypothesize that this is due to affordable tax arbitrage since it is easy to short on-the-run bills. Tax arbitrage may become prohibitively expensive when bills are less liquid. We also identify the specialness in off-the-run bills linked to the expiration of bills futures contracts as another factor related to the bill-note pricing discrepancy.

Publication Research Centre

Institute of Finance and Accounting

Series Number

FIN 334


IFA Working Paper

Available on ECCH


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