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theses

This dissertation proposes and tests a model for liquidity in the corporate bond market. It uses the second law of thermodynamics, to explain liquidity. In the academic literature from the physical sciences, it has been said that the principle of entropy gives rise to the regularities found in nature (Swenson 2000) [60]. The on-the-run phenomenon is regularly found in the bond markets. The on-the-run phenomenon is the yield difference observed when a new bond issue comes to market from the same issuer and gets a better price (lower yield given equivalent duration) from the market than the older issue. This is an apparent conflict with the no-arbitrage condition that two securities having the same risk and maturity must have the same price. This dissertation shows that this theoretical rule is, indeed, not violated. The yield differential is the illiquidity cost of the older issue that has increased as a result of progressing through stages which typically occur in an entropy process. This dissertation finds that a model employing an entropy measure largely explains the on-the-run phenomenon, by accounting for over two-thirds of the liquidity differential for on-the-run corporate bonds. Further, bond liquidity captured as entropy exhibits an equivalent explanatory impact on yield to maturity as credit risk. The study continues with a proposal to improve financial reporting by requiring firms to include aggregate entropy measures, by asset class, for all holdings of marketable securities, securities available-for-sale, and securities held-to-maturity, as a means of making financial reporting more relevant and informative. High entropy portfolios show superior performance in financial crisis periods, but will under perform low entropy portfolios in normal times.

ETD_4914

Ph.D.

Includes bibliographical references

Includes vita

by Anthony J. Anderson

doi:10.7282/T3W093WG

ETD doctoral

The author owns the copyright to this work.