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Ruslan Goyenko

Treasury Illiquidity and Funding Liquidity Risk. PRMIA-CIRANO- Lunch Conference December 7, 2011. Ruslan Goyenko. Treasury Illiquidity and Funding Liquidity Risk. What the paper does:. ILLIQUIDITY MARKET ILLIQUIDITY FUNDING LIQUIDITY We know how to measure How do we measure it?

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Ruslan Goyenko

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  1. Treasury Illiquidity and Funding Liquidity Risk PRMIA-CIRANO- Lunch ConferenceDecember 7, 2011 Ruslan Goyenko Treasury Illiquidity and Funding Liquidity Risk

  2. What the paper does: • ILLIQUIDITY • MARKET ILLIQUIDITY FUNDING LIQUIDITY • We know how to measure How do we measure it? • It is priced Is it priced? Christoffersen, Goyenko, Jacobs, and Karoui Ruslan Goyenko Illiquidity Premia in the Equity Options Market Treasury Illiquidity and Funding Liquidity Risk

  3. Treasury Illiquidity and Funding Liquidity Outflow from the stock market Reduced positions Price moves away from fundamentals Funding Problems Higher margins Losses on existing positions Christoffersen, Goyenko, Jacobs, and Karoui Ruslan Goyenko Illiquidity Premia in the Equity Options Market Treasury Illiquidity and Funding Liquidity Risk

  4. Treasury Illiquidity Christoffersen, Goyenko, Jacobs, and Karoui Ruslan Goyenko Illiquidity Premia in the Equity Options Market Treasury Illiquidity and Funding Liquidity Risk

  5. Treasury Illiquidity • Market Liquidity – reflects the ease of trading in bond markets (Goyenko, Subrahmanyam and Ukhov, JFQA, 2011) • Also predicts the ease of trading in the stock market (Goyenko and Ukhov, JFQA, 2009) • What else? Christoffersen, Goyenko, Jacobs, and Karoui Ruslan Goyenko Illiquidity Premia in the Equity Options Market Treasury Illiquidity and Funding Liquidity Risk

  6. TED SPREAD Christoffersen, Goyenko, Jacobs, and Karoui Ruslan Goyenko Illiquidity Premia in the Equity Options Market Treasury Illiquidity and Funding Liquidity Risk

  7. Treasury Illiquidity and Funding Liquidity For the sample period 01/1971 to 12/2009, correlation=0.78 Christoffersen, Goyenko, Jacobs, and Karoui Ruslan Goyenko Illiquidity Premia in the Equity Options Market Treasury Illiquidity and Funding Liquidity Risk

  8. VAR(2): FED, Stock Illiquidity, Bond Illiquidity and TED spread Christoffersen, Goyenko, Jacobs, and Karoui Ruslan Goyenko Illiquidity Premia in the Equity Options Market Treasury Illiquidity and Funding Liquidity Risk

  9. VAR(2): FED, Stock Illiquidity, Bond Illiquidity and TED spread Christoffersen, Goyenko, Jacobs, and Karoui Ruslan Goyenko Illiquidity Premia in the Equity Options Market Treasury Illiquidity and Funding Liquidity Risk

  10. Bond-ILLIQ beta portfolios, from 5-factor model Christoffersen, Goyenko, Jacobs, and Karoui Ruslan Goyenko Illiquidity Premia in the Equity Options Market Treasury Illiquidity and Funding Liquidity Risk

  11. Bond-ILLIQ beta portfolios, from 5-factor model Christoffersen, Goyenko, Jacobs, and Karoui Ruslan Goyenko Illiquidity Premia in the Equity Options Market Treasury Illiquidity and Funding Liquidity Risk

  12. Size-Bond ILLIQ Beta quintile portfolios (1/1971 to 12/2009) Christoffersen, Goyenko, Jacobs, and Karoui Ruslan Goyenko Illiquidity Premia in the Equity Options Market Treasury Illiquidity and Funding Liquidity Risk

  13. Amihud ILLIQ-Bond ILLIQ Beta quintile portfolios (1/1971 to 12/2009) Christoffersen, Goyenko, Jacobs, and Karoui Ruslan Goyenko Illiquidity Premia in the Equity Options Market Treasury Illiquidity and Funding Liquidity Risk

  14. Cross-Sectional Fama-MacBeth Regressions • The model • The loadings are pre-estimated from portfolios 10sizex10bond-beta (similar to Fama-French 1992) Christoffersen, Goyenko, Jacobs, and Karoui Ruslan Goyenko Illiquidity Premia in the Equity Options Market Treasury Illiquidity and Funding Liquidity Risk

  15. Risk Premiums Christoffersen, Goyenko, Jacobs, and Karoui Ruslan Goyenko Illiquidity Premia in the Equity Options Market Treasury Illiquidity and Funding Liquidity Risk

  16. Active Equity Mutual Funds and Funding Liquidity • Asset fire sales (Coval and Stafford, JFE, 2007) – fund manager needs to liquidate at below fundamental values when a fund underperforms and investors withdraw • Capital-constrained assets are even more difficult to liquidate • The main hypothesis: This extra risk of holding capital-constrained assets should have extra reward Christoffersen, Goyenko, Jacobs, and Karoui Ruslan Goyenko Illiquidity Premia in the Equity Options Market Treasury Illiquidity and Funding Liquidity Risk

  17. Active Equity Mutual Funds – 2,546 funds, 1/1990 to 12/2009 Bond Illiquidity-Beta Sorted Portfolios, monthly returns, 24-month rolling window Christoffersen, Goyenko, Jacobs, and Karoui Ruslan Goyenko Illiquidity Premia in the Equity Options Market Treasury Illiquidity and Funding Liquidity Risk

  18. Active Equity Mutual Funds and Funding Liquidity: Hypotheses • H1: Small size funds with higher bond illiquidity beta portfolios have higher risk-adjusted returns compared to medium and large funds with high/low beta portfolios • H2: Funds with higher expenses and higher bond illiquidity beta portfolio have higher risk adjusted returns compared to funds with low expenses and low/high beta portfolios • H3: Funds with higher turnover and higher bond illiquidity beta portfolio have higher risk adjusted returns compared to funds with low turnover and low/high beta portfolios Christoffersen, Goyenko, Jacobs, and Karoui Ruslan Goyenko Illiquidity Premia in the Equity Options Market Treasury Illiquidity and Funding Liquidity Risk

  19. Fund Size and Bond Illiquidity Risk Portfolios Christoffersen, Goyenko, Jacobs, and Karoui Ruslan Goyenko Illiquidity Premia in the Equity Options Market Treasury Illiquidity and Funding Liquidity Risk

  20. Fund Expenses and Bond Illiquidity Risk Portfolios Christoffersen, Goyenko, Jacobs, and Karoui Ruslan Goyenko Illiquidity Premia in the Equity Options Market Treasury Illiquidity and Funding Liquidity Risk

  21. Fund Turnover and Bond Illiquidity Risk Portfolios Christoffersen, Goyenko, Jacobs, and Karoui Ruslan Goyenko Illiquidity Premia in the Equity Options Market Treasury Illiquidity and Funding Liquidity Risk

  22. The effect of Bond Illiquidity Risk on fund performance: Panel Regression Christoffersen, Goyenko, Jacobs, and Karoui Ruslan Goyenko Illiquidity Premia in the Equity Options Market Treasury Illiquidity and Funding Liquidity Risk

  23. Conclusions • This paper links Treasury bond illiquidity and funding liquidity • Applications: stocks with higher bond illiquidity betas earn higher risk-adjusted returns compared to lower bond illiquidity beta stocks (49 basis points per month) • Bond illiquidity beta has positive and significant risk premium after controlling for Fama-French and Carhart factors and firm characteristics such as size, book-to-market and stock illiquidity. • Funds in the highest bond illiquidity beta decile outperform funds in the lowest decile by about 80 basis points per month. • Smaller funds and higher bond illiq-beta – higher alpha • Higher expenses and higher bond illiq-beta – higher alpha • Higher turnover and higher bond illiq-beta – higher alpha Christoffersen, Goyenko, Jacobs, and Karoui Ruslan Goyenko Illiquidity Premia in the Equity Options Market Treasury Illiquidity and Funding Liquidity Risk

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