This thesis consists of two studies on financial market imperfections. The first study (Chapters 2 and 3) investigates illiquidity, which is a reflection of different imperfections, and its pricing implications in the corporate bond market. The second study (Chapter 4) evaluates the impact of a short-sale ban, which is a form of financial constraints, on the equity and derivatives markets. In C...

We survey the theoretical literature on market liquidity. The literature traces illiquidity, i.e., the lack of liquidity, to underlying market imperfections. We consider six main imperfections: participation costs, transaction costs, asymmetric information, imperfect competition, funding constraints, and search. We address three questions in the context of each imperfection: (a) how to measure ...

This paper analyzes the portfolio decision of an investor facing the threat of illiquidity. In a continuous-time setting, the efficiency loss due to illiquidity is addressed and quantified. We show that the efficiency loss for a logarithmic investor with 30 years until the investment horizon is a significant 22.7% of current wealth if the illiquidity part of the model is calibrated to the Japan...

This paper investigates U.S. bank common stock returns and their sensitivity to market risk, interest rate risk, and illiquidity risk. Due to known problems with conducting inference using Generalized Method of Moments, I use the Empirical Likelihood Block Bootstrap established in Allen, Gregory, and Shimotsu (2004). Preliminary results suggest that once the test-statistics are bootstrapped, ag...

Available online 30 April 2015 This paper tests the relation between expected excess stock returns and illiquidity risk in G7 markets. By conducting panel regressions on monthly data for 20 years, evidence shows that excess stock returns of the G7 countries are positively correlated with market illiquidity risk, but are negatively correlated with the innovation of firm-level illiquidity. Applyi...

Background: Liquidity is, in practice of portfolio investment, an important attribute of stocks and measuring illiquidity presents a real challenge for researchers, primarily on developed stock markets. Moreover, there is a lack of research dealing with (il)liquidity on emerging markets. In the paper, the problem of applicability and validity of two well-known illiquidity measures, ILLIQ and TU...

This paper proposes a theory of liquidity dynamics. Illiquidity results from asymmetric information. Observing the historical track record teaches agents how to interpret public information and helps overcome information asymmetry. There can be an illiquidity trap: too much asymmetric information leads to the breakdown of trade, which interrupts learning and perpetuates illiquidity. Liquidity f...

Illiquidity and default risk are determinants of bond spreads that models suggest vary across the term structure and across market states. But existent attempts to empirically identify the separate impact of these factors are affected by correlation between them. The Australian sovereign debt market, where the Australian government provided an explicit guarantee over semi-government debt, provi...

We investigate how the inability to continuously trade an asset affects portfolio choice. We extend the standard Merton model to include an illiquid asset that can only be traded at infrequent, stochastic intervals. Because consumption is financed through liquid wealth only, the presence of illiquidity leads to increased and state-dependent risk aversion. Illiquidity leads to under-investment i...

This paper examines liquidity premium focusing on the difference between offshore and onshore hedge funds. Due to tax provisions and regulatory concerns, offshore and onshore hedge funds have different legal structures, which lead to differences in share restrictions such as a lockup provision. We find that offshore investors collect higher illiquidity premium when their investment has the same...