Edwin J Elton, T Clifton Green
ABSTRACT
Daily data from intra-dealer government bond brokers is examined for
tax and liquidity effects. Utilizing actual trade prices rather than dealer
estimated quotes gives us a more accurate measure of market clearing prices.
Daily trading volume is also available, which provides us with a robust
measure of liquidity. We use two approaches, one of which is new, to create
cash flow matching portfolios of similar securities and look for pricing
discrepancies associated with liquidity or tax effects. We also look for
evidence of tax and liquidity effects by including a liquidity term when
fitting a cubic spine to the after-tax yield curve. We find evidence of
tax timing options and liquidity effects. However, the effects are much
smaller than previously reported and the effects of liquidity are primarily
due to high volume bond with long maturities.
Subject: Investment fixed income (Empirical)
Elton: (212) 998-0361 eelton@stern.nyu.edu
Green: (212) 998-0319 tgreen@stern.nyu.edu
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