DOCSLIB.ORG

Essays on Bond Exchange-Traded Funds

Total Page：16

File Type：pdf, Size：1020Kb

Download full-text PDF Read full-text
Essays on Bond Exchange-Traded Funds ESSAYS ON BOND EXCHANGE-TRADED FUNDS by Charles W. Evans A Dissertation Submitted to the Faculty of The College of Business in Partial Fulfillment of the Requirements for the Degree of Doctor of Philosophy Florida Atlantic University Boca Raton, Florida August 2011 ESSAYS ON BOND EXCHANGE-TRADED FUNDS by Charles W. Evans This dissertation was prepared under the direction of the candidate's dissertation advisor, Dr. Antoine Giannetti, Department of Finance, and has been approved by the members ofhis supervisory committee. It was submitted to the faculty of the College of Business and was accepted in partial fulfillment of the requirements for the degree of Doctor ofPhilosophy. SUPERVISORY COMMTITEE: ~e~ Dissertation Advisor 1A0 Emilio Zarruk, Ph.D. hair epartrnent ance / J. Dennis Coates, Ph.D. Dean, College of Business n--- B!71oSS:P~/??--- :J11¥l? ZJ, ?-P// Date Dean, Graduate College u ii ACKNOWLEDGEMENTS The author wishes to express his sincere thanks and love to his wife, Lina, for her support throughout the writing of this manuscript and the coursework that preceded it. The author is thankful for the unwavering encouragement of his dissertation committee members, Dr. Anna Agapova, Dr. William R. McDaniel, Dr. Ariel Viale, and especially his dissertation chairman, Dr. Antoine Giannetti, whose efforts and inspiration have been instrumental in the completion of this dissertation. The author is grateful to the chairman, Dr. Emilio Zarruk, and secretaries, Joan Schlossberg, Eileen Schneider, and Myrna Sotolongo, of the College of Business Department of Finance and Economics at Florida Atlantic University for providing financial and technical support for the research and writing of this manuscript, and to Judith Benson and Dr. Jeff Madura for their help with navigating the program. A special debt of gratitude goes to Geoff Gitlen, Will Johnson, and Steve Foerster for their camaraderie and commiseration. iii ABSTRACT Author: Charles W. Evans Title: Essays on Bond Exchange-Traded Funds Institution: Florida Atlantic University Dissertation Advisor: Dr. Antoine Giannetti Degree: Doctor of Philosophy Year: 2011 This dissertation investigates two fundamental questions related to how well exchange-traded funds that hold portfolios of fixed-income assets (bond ETFs) proxy for their underlying portfolios. The first question involves price/net-asset-value (NAV) mean-reversion asymmetries and the effectiveness of the arbitrage mechanism of bond ETFs. Methodologically, to answer the first question I focus on a time-series analysis. The second question involves the degree to which average returns of bond ETF shares respond to changes in factors that have been found to drive average returns of bond portfolios. To answer this question I shift the focus of the analysis to a cross-section asset pricing test. In other words, do bond ETF share prices track the value of their underlying assets, and are they priced by investors like bonds in the cross-section? The first essay concludes that bond ETF shares exhibit mean-reversion asymmetries when price and NAV diverge, along persistent small premiums. These premiums appear to reflect the added value that bond ETFs bring to the fixed-income iv asset market through smaller trading increments, greater liquidity, and the ability to buy on margin and sell short. The second essay concludes that market, bond-specific, and firm-specific risk factors can help to explain the variation in U.S. bond ETF average returns, but only size seems to be priced in the cross-section of expected returns. This is not surprising as the sample used in the asset pricing tests is limited to the period 2007-2010, which corresponds to the „great recession‟, and size has been interpreted in the asset pricing literature as a state variable that proxies for financial distress and is highly dependent on the phase of the real business cycle. The two essays together suggest that bond ETFs can be used in trading strategies based on taking long and short positions in fixed-income assets, especially when trading in portfolios of fixed-income assets directly is not feasible. v ESSAYS ON BOND EXCHANGE-TRADED FUNDS List of Tables viii List of Figures ix Chapter 1: Bond Exchange-Traded Funds 1 Background 3 Bond ETFs 6 ETFs vs CEFs, OEFs, and OTC 8 Comparison 8 Substitution Effects 10 Liquidity 12 Noise Traders 13 Bond ETF Trading Strategies 15 Chapter 2: Bond ETF Mean-Reversion Asymmetries 18 Introduction 19 Background 22 Empirical Framework 23 Data and Methodology 25 Data 25 Methodology 28 Test of the Law of One Price 28 vi Test of Mean-Reversion Asymmetries 29 Liquidity and Behavioral Explanatory Variables 31 Empirical Results 36 Law of One Price 36 Mean-Reversion Asymmetries 38 Expanded ECM 39 Expanded Rockets & Feathers 42 Conclusion 44 Chapter 3: Risk Factors in the Returns and Premiums of Bond ETFs 46 Introduction 47 Literature Review 50 Methodological Approach 56 Data 56 Asset Pricing Tests 57 Empirical Results 60 Stylized Time Series Properties of Bond ETF Excess Returns 60 Fama-MacBeth CSR Asset Pricing Test Results 63 Fixed Effects Static Panel Data Results 64 Concluding Remarks and Future Research 66 References 94 vii TABLES 1: Descriptive Statistics 68 2: ECM / Rockets & Feathers 71 3: Expanded ECM 73 4: Expanded Rockets & Feathers 75 5: Descriptive Statistics 77 6: Time Series: Bond Factors 79 7: Time Series: Stock and Market Factors 81 8: Time Series: Five-Factor Model 83 9: GLS 85 10: ICAPM 86 11: Panel Data 87 viii FIGURES Fig. 1: Monthly Number of Shares Outstanding (HYG) 88 Fig. 2: Monthly Percentage Growth in Shares Outstanding (HYG) 89 Fig. 3: Daily Premium/Discount (HYG) 90 Fig. 4: Bond ETF Market Growth 91 Fig. 5: ETF, CEF, OEF, OTC Comparison 92 Fig. 6: Trading Strategies 93 ix CHAPTER 1 Bond Exchange-Traded Funds Four core fixed-income exchange-traded funds (bond ETFs) were introduced in the United States in 2002 that focus on investment-grade government and corporate debt. Two more were issued in 2003, and the entire bond ETF market consisted of these six until the end of 2006. Beginning in 2007, bond ETFs have been issued that hold emerging-market, municipal, high-yield corporate, government agency, and mortgage- backed debt, with a range of maturities and risk profiles within each category. Now, retail traders, who are unable to participate actively in the bond market, are able to trade a wide variety of bond portfolios intra-day, to short-sell, and to buy on margin at a price that is close to the net asset value (NAV) and in increments that are within the budgets of retail traders. The law of one price – equating ETF share price with NAV – is expected to be enforced by the Authorized Participant (AP) arbitrage mechanism, through which large institutional investors that have entered into contractual arrangements with ETF issuers can create and redeem shares directly, in exchange for bundles of underlying assets, when price diverges from NAV. However, the magnitudes of bond ETF premiums and discounts often exceed daily bid-ask spreads in the short run, and shares exhibit small, persistent premiums, meaning that the price is more likely to exceed the reported NAV slightly than to be precisely equal to or less than NAV. 1 ETFs are designed to mimic their underlying portfolios and to trade on formal stock exchanges. However, the vast majority of the underlying assets of bond ETFs trade over the counter (OTC), which raises the question of how well bond ETFs have served as proxies for the categories of bonds in their underlying portfolios assets in these early days following their initial inception, both in terms of how well prices track corresponding NAVs and to what degree ETF share returns behave like bond returns in response to shocks in bond and stock markets. This dissertation's major contribution is to address these questions and to show that, even though bond ETFs differ from their underlying assets, their share price and return behavior have been sufficiently similar for them to be used in trading strategies in which trading in fixed-income asset portfolios is not practical or even possible. This is remarkable, considering that this early period of their existence has coincided with major turmoil in both the debt and the equity markets. Specifically, I identify persistent premiums, confirm price/NAV mean-reversion using a dynamic model, and analyze mean-reversion asymmetries that favor premiums over discounts. This last point is different from the case with closed-end funds, which tend to exhibit persistent and significant discounts, discussed in detail below. I also show that factors that have been shown in the financial literature to help to explain the cross-section of average bond returns also help to explain the cross-section of bond ETF average returns. 2 1.1. Background ETFs, like conventional open-end (OEF) and closed-end (CEF) funds, are vehicles for trading entire portfolios in single transactions. ETFs are structured to combine the best features of OEFs and CEFs. Similar to OEFs, which trade at NAV, ETFs are designed to trade at or near net asset value (NAV), and like CEFs, to trade as shares on formal exchanges (Barnhart & Rosenstein, 2009; Gastineau, 2001). Unique to the ETF market is the AP, a participant in the Depository Trust Company (DTC) that enters into a formal AP agreement with the fund's issuer and the appropriate custodian bank. The AP arbitrage mechanism causes ETF shares to be created and liquidated through in-kind transfers of underlying assets. If the underlying assets are non-transferrable, as is the case with mortgage-backed securities and Treasury Inflation-Protected Securities (TIPS), the cash equivalent is paid1. (Vanguard, 2009) With OEFs, the size of the fund varies as investors buy (sell) shares directly from (to) the issuer.
Load more

Recommended publications
  • BIS Working Papers No 532 Mortgage Risk and the Yield Curve
    BIS Working Papers No 532 Mortgage risk and the yield curve by Aytek Malkhozov, Philippe Mueller, Andrea Vedolin and Gyuri Venter Monetary and Economic Department December 2015 JEL classification: G12, G21, E43 Keywords: Term Structure of Interest Rates, MBS, Supply Factor BIS Working Papers are written by members of the Monetary and Economic Department of the Bank for International Settlements, and from time to time by other economists, and are published by the Bank. The papers are on subjects of topical interest and are technical in character. The views expressed in them are those of their authors and not necessarily the views of the BIS. This publication is available on the BIS website (www.bis.org). © Bank for International Settlements 2015. All rights reserved. Brief excerpts may be reproduced or translated provided the source is stated. ISSN 1020-0959 (print) ISSN 1682-7678 (online) Mortgage Risk and the Yield Curve∗ Aytek Malkhozov† Philippe Mueller‡ Andrea Vedolin§ Gyuri Venter¶ Abstract We study the feedback from the risk of outstanding mortgage-backed secu- rities (MBS) on the level and volatility of interest rates. We incorporate the supply shocks resulting from changes in MBS duration into a parsimonious equilibrium dynamic term structure model and derive three predictions that are strongly supported in the data: (i) MBS duration positively predicts nominal and real excess bond returns, especially for longer maturities; (ii) the predictive power of MBS duration is transitory in nature; and (iii) MBS convexity increases interest
    [Show full text]
  • WHY DOES the YIELD CURVE PREDICT ECONOMIC ACTIVITY? Dissecting the Evidence for Germany and the United States
    BIS WORKING PAPERS No. 49 WHY DOES THE YIELD CURVE PREDICT ECONOMIC ACTIVITY? Dissecting the evidence for Germany and the United States by Frank Smets and Kostas Tsatsaronis September 1997 BANK FOR INTERNATIONAL SETTLEMENTS Monetary and Economic Department BASLE BIS Working Papers are written by members of the Monetary and Economic Department of the Bank for International Settlements, and from time to time by other economists, and are published by the Bank. The papers are on subjects of topical interest and are technical in character. The views expressed in them are those of their authors and not necessarily the views of the BIS. © Bank for International Settlements 1997 CH-4002 Basle, Switzerland Also available on the BIS World Wide Web site (http://www.bis.org). All rights reserved. Brief excerpts may be reproduced or translated provided the source is stated. ISSN 1020-0959 WHY DOES THE YIELD CURVE PREDICT ECONOMIC ACTIVITY? Dissecting the evidence for Germany and the United States by Frank Smets and Kostas Tsatsaronis * September 1997 Abstract This paper investigates why the slope of the yield curve predicts future economic activity in Germany and the United States. A structural VAR is used to identify aggregate supply, aggregate demand, monetary policy and inflation scare shocks and to analyse their effects on the real, nominal and term premium components of the term spread and on output. In both countries demand and monetary policy shocks contribute to the covariance between output growth and the lagged term spread, while inflation scares do not. As the latter are more important in the United States, they reduce the predictive content of the term spread in that country.
    [Show full text]
  • Notes on the Yield Curve
    Notes on the yield curve Ian Martin Steve Ross∗ September, 2018 Abstract We study the properties of the yield curve under the assumptions that (i) the fixed-income market is complete and (ii) the state vector that drives interest rates follows a finite discrete-time Markov chain. We focus in particular on the relationship between the behavior of the long end of the yield curve and the recovered time discount factor and marginal utilities of a pseudo-representative agent; and on the relationship between the \trappedness" of an economy and the convergence of yields at the long end. JEL code: G12. Keywords: yield curve, term structure, recovery theorem, traps, Cheeger inequality, eigenvalue gap. ∗Ian Martin (corresponding author): London School of Economics, London, UK, [email protected]. Steve Ross: MIT Sloan, Cambridge, MA. We are grateful to Dave Backus, Ravi Bansal, John Campbell, Mike Chernov, Darrell Duffie, Lars Hansen, Ken Singleton, Leifu Zhang, and to participants at the TIGER Forum and at the SITE conference for their comments. Ian Martin is grateful for support from the ERC under Starting Grant 639744. 1 In this paper, we present some theoretical results on the properties of the long end of the yield curve. Our results relate to two literatures. The first is the Recovery Theorem of Ross (2015). Ross showed that, given a matrix of Arrow{Debreu prices, it is possible to infer the objective state transition probabilities and marginal utilities. Although it is a familiar fact that sufficiently rich asset price data pins down the risk-neutral probabilities, it is initially surprising that we can do the same for the objective, or real-world, probabilities.
    [Show full text]
  • A Warning to Bond Bears
    A warning to bond bears Curt Custard | UBS Global Asset Management | July 2014 American bond bulls are a hardy species. A bond bull born in the early 1980s would have enjoyed a healthy life over at least three decades in the US. Why should other countries care about US bond yields? The topic matters for investors everywhere, since US Treasuries are the world’s biggest bond market, and to some extent set the pace for global bond markets – witness the global jump in yields when the Federal Reserve surprised investors with talk of ‘tapering’ in June 2013. And on days when bond yields jump up, equities tend to jump down – again, we saw this in global equities markets in June 2013. Every investor should therefore care about the future direction of US bond markets. The bull market that started when 10- year US Treasury yields peaked in 1981 may or may not be over. The 10-year yield dropped to a record low of 1.4% in July 2012. Was that a trough that won’t be revisited for decades, or just the latest in a succession of new records in a secular bull market that is still going? It’s too early to say. Many commentators had made up their minds by the end of last year. As we closed 2013, most investors looked at their checklist of factors that hurt US government bond prices. Improving economy? Check. Falling unemployment? Check. Tapering of quantitative easing by the Federal Reserve? Check. And so on – other factors such as steep yield curves and low real yields also supported the ‘safe bet’ that yields would go higher.
    [Show full text]
  • Should We Fear the Inverted Yield Curve?
    PAGE ONE Economics® Should We Fear the Inverted Yield Curve? Diego Mendez-Carbajo, Ph.D., Senior Economic Education Specialist GLOSSARY “What, me worry?” Bond: A certificate of indebtedness issued —Alfred E. Neuman (MAD magazine) by a government or corporation. Coupon (of bonds): The regular payments received by the buyer of a bond. On August 14, 2019, news outlets widely carried news of a “yield curve Face value (of bonds): The dollar amount inversion.” Stock market indexes dramatically dropped in value, and Google paid to the bond holder when a bond searches for the word “recession” peaked. What is the yield curve? How matures. does it invert? Why does it matter? Should we worry about it? Maturity (of bonds): The time period during which a bond makes coupon payments. U.S. Bonds and Yields Yield curve: A graph that shows the yields of bonds with different maturity dates. Both the federal government and corporations borrow money by selling bonds when their expenses are larger than their revenue. Bonds are certifi- Yield (of bonds): The return from owning a bond. It depends on the price paid for cates of indebtedness (i.e., IOUs) entitling the buyer of the bond to a regular the bond, its coupon payments, and its stream of payments (called coupons) for a period of time (called maturity). face value. The time until the last payment is called the remaining maturity of the bond. When a bond matures, the issuer of the bond returns to the buyer of the bond the amount borrowed (called the face value of the bond).
    [Show full text]
  • Yield Curves and the Recession Expectations
    Balkan and Near Eastern Journal of Social Sciences Yılmaz, 2020: 06 (03) BNEJSS Balkan ve Yakın Doğu Sosyal Bilimler Dergisi Yield Curves and the Recession Expectations Rasim Yılmaz1 1Prof.Dr., Tekirdağ Namık Kemal University, Faculty of Economics and Administrative Sciences, Department of Economics, [email protected], ORCID: 0000-0002-1084-8705 Abstract: The curve representing the returns of bonds bearing the same risk, liquidity and tax conditions but with different maturities is called yield curve. The yield curve typically slopes upward, i.e. longer-maturity assets have a higher return than shorter-maturity assets, due to the fact that investors demand a premium to hold a bond or a note for a longer period. The premium is demanded for risks such as inflation and other uncertainties that can develop over time. A flatter yield curve signals concerns about the future economic outlook while an inverted yield curve is considered as a warning sign about the future economic outlook. When the short-term asset rates rise above the rates on long-term assets, i.e. the spread is negative, yield curve inversions occur. Interest rates increases in periods of economic expansion, while interest rates decrease in periods of economic recession. The horizontal and negative slope of the yield curve indicates that short- term interest rates are expected to fall. Therefore, the economy is expected to enter a recession. The recent flattening and inversion of the yield curve in the USA have triggered the discussions about the recession expectations in the USA. Key Words: Yield Curve, Recession, Globalization 1. INTRODUCTION Figure 1: The Slope of Yield Curves Risk, liquidity and tax conditions (risk structure) affect the interest rates of the bonds.
    [Show full text]
  • Economic Forecasts with the Yield Curve Michael D
    FRBSF Economic Letter 2018-07 | March 5, 2018 | Research from Federal Reserve Bank of San Francisco Economic Forecasts with the Yield Curve Michael D. Bauer and Thomas M. Mertens The term spread—the difference between long-term and short-term interest rates—is a strikingly accurate predictor of future economic activity. Every U.S. recession in the past 60 years was preceded by a negative term spread, that is, an inverted yield curve. Furthermore, a negative term spread was always followed by an economic slowdown and, except for one time, by a recession. While the current environment is somewhat special—with low interest rates and risk premiums—the power of the term spread to predict economic slowdowns appears intact. One of the most pervasive relationships in macroeconomics is that between the term spread—the difference between long-term and short-term interest rates—and future economic activity. A negative term spread, that is, an inverted yield curve, reliably predicts low future output growth and indicates a high probability of recession (Rudebusch and Williams 2009). This relationship holds not only in the United States but also for a number of other advanced economies (Estrella and Mishkin 1997). The term spread is one of the most reliable predictors of future economic activity among a wide range of economic and financial indicators and, as such, is closely watched by professional forecasters and policymakers alike. Over most of the current recovery, particularly in 2017, the yield curve has flattened. As of the end of February, the difference between the ten-year and one-year Treasury yields stands at only 0.8%.
    [Show full text]
  • An Overview of the Quadratic Interest Rate Volatility and Inflation Hedge ETF (NYSE Ticker: IVOL)
    An Overview of the Quadratic Interest Rate Volatility and Inflation Hedge ETF (NYSE Ticker: IVOL) About Quadratic Capital Management Quadratic Capital Management is an innovative asset management firm founded in 2013 by Nancy Davis. The firm has utilized its significant expertise in the interest rate volatility and options markets to construct IVOL. Why IVOL? Many portfolios limit their exposure to stocks and bonds. IVOL accesses the U.S. Government and OTC rates markets. The OTC rates market is nearly five times larger than the stock market. The IVOL ETF provides diversification to an often inaccessible part of the market that is very different from stock and bond portfolios. [email protected] 1 The Quadratic Team and IVOL Partners The Quadratic Team Nancy Davis Glenn Christal Henrique Rocha Brooke Farley CIO & Managing Partner COO & CCO Market Strategist Business Development 21 Years of Experience 32 Years of Experience 10 Years of Experience 30 Years of Experience • Head of Credit, • Treasurer of Tudor, 15 • Goldman Sachs Rates • Former McKinsey Derivatives and OTC years and FX Strategist Research consultant Trading for Goldman • COO of Millennium • Investment experience at • MIA from Columbia Sachs Prop Desk Partners firms in both Brazil and University School of • Highbridge Capital and the U.S. International Affairs AllianceBernstein IVOL Partners Fund Listing ETF Custodian ETF Platform Administration Exchange Auditors 2 The IVOL Ecosystem NAV-Based Creates Market Orders Investor Large Institutions RIA’s Individuals Execution Authorized Participants Individual Brokerage Account Function of the value of the Function of the value of ETF shares Liquidity underlying asset that backs traded the ETF Flexible supply - shares can Trading the ETF shares that currently Shares be "created" or "redeemed" to exist offset changes in demand 3 Dilemmas currently faced by investors • Investors need income yet rates are very low globally Data from Bloomberg as of 04/30/2020.
    [Show full text]
  • PIMCO's Capital Market Assumptions, June 2020
    IN DEPTH • JUN 2020 PIMCO’s Capital Market Assumptions, June 2020. Executive Summary PIMCO traditionally updates our Capital Market Assumptions at the end of June and December, but we’ve advanced this release given the pandemic and the extreme volatility that resulted. We now expect the U.S. cash rate to average just slightly higher than zero over the secular horizon, a dramatic downshift from the fourth quarter of last year, while we’ve increased our long-term outlook for most credit sectors amid a general widening in credit spreads. Other forecasts include: • Somewhat low U.S. Treasury yields and returns by historical standards • A favorable long-term outlook for various credit sectors on both an absolute return and Sharpe ratio basis • A modestly higher expected return for Treasury Inflation-Protected Securities (TIPS) relative to Treasuries • A generally favorable long-term outlook for non-U.S. developed market and emerging market currencies given our view of a relatively expensive U.S. dollar today • A favorable outlook for emerging markets due to relatively attractive valuations in terms of credit spreads and equity yields, despite the potential for greater volatility. When we last updated our capital market assumptions (CMAs) Markets continued to decline in early March as the U.S. in Q4 2019, we were generally cautious on risk assets, given the government began to mandate unprecedented shutdowns of long-running risk appetite that investors had exhibited over the businesses and impose shelter-in-place requirements in an past decade. Last year was no exception to this secular trend, attempt to contain the spread of the novel coronavirus.
    [Show full text]
  • OR03/2021 Exchange Traded Funds Thematic Note
    Exchange Traded Funds Thematic Note - Findings and Observations during COVID-19 induced market stresses Public Report The Board OF THE INTERNATIONAL ORGANIZATION OF SECURITIES COMMISSIONS OR03 AUGUST 2021 The unprecedented nature of the COVID-19 pandemic brought severe shock to the financial markets. At the height of the market turmoil in March and April 2020, exchange traded funds (ETFs) in various markets went through a stress period. This note reviews the operation and activities of the primary market and secondary market of ETFs during such a period. In particular, it explores the impact of the stress on the ETF structure and functioning, including the causes of the substantial pricing differences between some fixed income ETFs’ secondary market prices and their Net Asset Values (NAVs). It also outlines some challenging circumstances concerning some derivatives-based ETFs. The information sources drawn on by this note include, among others: • Data analysis compiled by a core research group (CRG) from IOSCO’s Committee 5 on Investment Management (C5); • Responses to a survey from 24 C5 members; and • Responses to an industry survey from 49 industry participants. By examining the aforementioned, this note seeks to review the resilience of the ETF structure during the COVID-19 volatility. Overall, available evidence, including data analytics and feedback from C5 members and industry participants, has not indicated any major risks or fragilities in the ETF structure although a subset of ETFs temporarily experienced unusual trading behaviors. The COVID-19 volatility has shed light on the resilience of most ETFs across various market segments during stressed markets. There is an emerging consensus that fixed income ETFs could provide useful pricing information to the wider market.
    [Show full text]
  • Noise As Information for Illiquidity
    NBER WORKING PAPER SERIES NOISE AS INFORMATION FOR ILLIQUIDITY Xing Hu Jun Pan Jiang Wang Working Paper 16468 http://www.nber.org/papers/w16468 NATIONAL BUREAU OF ECONOMIC RESEARCH 1050 Massachusetts Avenue Cambridge, MA 02138 October 2010 The authors thank Adrien Verdelhan for valuable discussions. The views expressed herein are those of the author and do not necessarily reflect the views of the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peer- reviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications. © 2010 by Xing Hu, Jun Pan, and Jiang Wang. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source. Noise as Information for Illiquidity Xing Hu, Jun Pan, and Jiang Wang NBER Working Paper No. 16468 October 2010 JEL No. G0 ABSTRACT We propose a broad measure of liquidity for the overall financial market by exploiting its connection with the amount of arbitrage capital in the market and the potential impact on price deviations in US Treasurys. When arbitrage capital is abundant, we expect the arbitrage forces to smooth out the Treasury yield curve and keep the dispersion low. During market crises, the shortage of arbitrage capital leaves the yields to move more freely relative to the curve, resulting in more "noise.'' As such, noise in the Treasury market can be informative and we expect this information about liquidity to reflect the broad market conditions because of the central importance of the Treasury market and its low intrinsic noise — high liquidity and low credit risk.
    [Show full text]
  • Glossary of Commodity Futures Terms, Introduction to Futures Language
    NATIONAL FUTURES ASSOCIATION Glossary of Futures Terms An Introduction to the Language of the Futures Industry 1 Glossary of Futures Terms: An Introduction to the Language of the Futures Industry National Futures Association (NFA) has been designated by the Commod- ity Futures Trading Commission (CFTC) as a registered futures asso- ciation. Its mission is to provide inno- vative regulatory programs and services that ensure futures industry integrity, protect market participants and help its members meet their regulatory responsibilities. Some of the terms included in this glossary may have complex legal or technical meanings which are beyond the scope of the booklet. However, this glossary does provide a good intro- duction to the language of the futures industry. 2 Actuals Actuals See Cash Commodity. Aggregation The policy under which all futures positions owned or controlled by one trader or a group of traders are combined to determine report- able positions and speculative limits. Arbitrage The simultaneous purchase and sale of similar commodities in different markets to take ad- vantage of a price discrepancy. Arbitration The process of settling disputes between par- ties by a person or persons chosen or agreed to by them. NFA’s arbitration program provides a forum for resolving futures-related disputes between NFA Members or between Members and customers. Associated Person (AP) An individual who solicits orders, customers or customer funds on behalf of a Futures Commission Merchant, an Introducing Broker, a Commodity Trading Advisor or a Commodity Pool Operator and who is registered with the Commodity Futures Trading Commission. At-the-Money Option An option whose strike price is equal—or approximately equal—to the current market price of the underlying futures contract.
    [Show full text]