In Japan, almost identical government bonds can trade at large price differentials. Motivated by this phenomenon, we examine the issue of the value of liquidity in markets for riskless securities. We develop a model of an issuer of bonds, a market maker, and heterogeneous investors trading in an incomplete market. We show not only that divergent prices for similar securities can be sustained in a rational expectations equilibrium, but also that this divergence may be optimal from the perspective of the issuer. Price segmentation is possible because agents have a desire to trade, but short-sale restrictions limit their trading strategies and prevent them from forcing bond prices to be equal. Restricting the form of market making to exclude price competition and unregulated profit maximization is also necessary to sustain price segmentation. The optimality of segmentation from the issuer's standpoint arises because of the issuer's ability to charge for the liquidity services provided to the investors.

[In Japan, almost identical government bonds can trade at large price differentials. Motivated by this phenomenon, we examine the issue of the value of liquidity in markets for riskless securities. We develop a model of an issuer of bonds, a market maker, and heterogeneous investors trading in an incomplete market. We show not only that divergent prices for similar securities can be sustained in a rational expectations equilibrium, but also that this divergence may be optimal from the perspective of the issuer. Price segmentation is possible because agents have a desire to trade, but short-sale restrictions limit their trading strategies and prevent them from forcing bond prices to be equal. Restricting the form of market making to exclude price competition and unregulated profit maximization is also necessary to sustain price segmentation. The optimality of segmentation from the issuer's standpoint arises because of the issuer's ability to charge for the liquidity services provided to the investors.]

[The prevailing view in finance is that the evidence for long-horizon stock return predictability is significantly stronger than that for short horizons. We show that for persistent regressors, a characteristic of most of the predictive variables used in the literature, the estimators are almost perfectly correlated across horizons under the null hypothesis of no predictability. For the persistence levels of dividend yields, the analytical correlation is 99% between the 1- and 2-year horizon estimators and 94% between the 1- and 5-year horizons. Common sampling error across equations leads to ordinary least squares coefficient estimates and R²s that are roughly proportional to the horizon under the null hypothesis. This is the precise pattern found in the data. We perform joint tests across horizons for a variety of explanatory variables and provide an alternative view of the existing evidence.]

[This article reexamines the autocorrelation patterns of short-horizon stock returns. We document empirical results which imply that these autocorrelations have been overstated in the existing literature. Based on several new insights, we provide support for a market efficiency-based explanation of the evidence. Our analysis suggests that institutional factors are the most likely source of the autocorrelation patterns.]

The authors investigate the cross-sectional relation between industry-sorted stock returns and expected inflation, and they find that this relation is linked to cyclical movements in industry output. Stock returns of noncyclical industries tend to covary positively with expected inflation, while the reverse holds for cyclical industries. From a theoretical perspective, the authors describe a model that captures both (1) the cross-sectional variation in these relations across industries and (2) the negative and positive relation between stock returns and inflation at short and long horizons, respectively. The model is developed in an economic environment in which the spirit of the Fisher model is preserved.

Multivariate density estimation (MDE) suggests that mortgage-backed security (MBS) prices can be well described as a function of the level and slope of the term structure. We analyze how this function varies across MBSs with different coupons. An important finding is that the interest rate level proxies for the moneyness of the option, the expected level of prepayments, and the average life of the cash flows, while the term structure slope controls for the average rate at which these cash flows should be discounted. Though the origination and prepayment behavior of mortgages differ substantially across coupons, there remains an unexplained common factor in MBS prices. This factor does not seem to be related to the usual suspects and therefore presents a puzzle to financial economists.

Two main empirical facts regarding the statistical relation between stock returns and inflation emerge from the current literature in finance. The first is that ex post nominal stock returns and inflation are negatively correlated. Financial economists consider this result surprising since stocks, as claims against real assets, should compensate for movements in inflation. The second, and related, empirical result documents a negative relation between ex ante nominal stock returns and ex ante inflation. Since the Fisher model implies that expected nominal rates should move one-forone with expected inflation, this negative correlation strikes at the heart of one of the oldest and most respected financial models (see e.g., John Lintner, 1975; Zvie Bodie, 1976; Charles Nelson, 1976; Eugene Fama and G. William Schwert, 1977; Jeffrey Jaffe and Gershon Mandelker, 1977; N. Bulent Gultekin, 1983; Gautam Kaul, 1987). Existing studies, however, have focused almost exclusively upon short-term asset returns with time horizons of one year and less.1 Since the Fisher model (and its corresponding intuition) might be expected to hold at all horizon lengths, this void in the empirical literature is unfortunate for several reasons. First, from a practical perspective, many investors hold stocks over long holding periods. Therefore, it is important to know the manner in which stock returns move with inflation over longer horizons. Second, the relation between stock returns and inflation at long horizons is of particular interest given that the results at short horizons (both ex ante and ex post) appear to be anomalous. That is, evidence at these longer horizons may provide additional information regarding explanations for the negative correlation between nominal stock returns and both ex ante and ex post inflation. In this paper, the relation between stock returns and inflation at long horizons is examined. In approaching this issue, several problems arise which must be addressed. The first difficulty is the necessity for a long data sample in order to capture long-term movements in the time series of returns. We have been able to accumulate two centuries of data on stocks, short-term and long-term bonds, and inflation in both the United States and the United Kingdom in order to fulfill this requirement. The second difficulty results from the inability to model ex ante long-term inflation accurately. We circumvent the absence of any long-horizon inflation model by using an instrumental* Finance Department, Stern School of Business, New York University, New York, NY 10012, and Finance Department, Wharton School of Finance and Commerce, University of Pennsylvania, Philadelphia, PA 19104-6367, respectively. An earlier version of the paper was circulated under the title, Stocks Are a Good Hedge for Inflation (in the Long Run). We thank Pierluigi Balduzzi, Bob Cumby, Silverio Foresi, Yasushi Hamao, Julie Richardson, Jeremy Siegel, Tom Smith, participants at the Western Finance Association meetings (San Francisco, 1992), and two anonymous referees for their helpful comments and suggestions. Special thanks to Tim Opler and Jeremy Siegel for use of the data. The authors gratefully acknowledge research support from the New York University Salomon Center (Boudoukh), and the Geewax-Terker Research Foundation (Richardson). IAs a representative sample of this literature, in their study of a variety of assets, Fama and Schwert (1977) document a negative relation between ex ante stock returns and expected inflation using monthly, quarterly, and semiannual data.

Abstract It is well-documented that government bonds with almost identical cash flows can trade at different prices. This article analyzes the cross-section of bond spreads across developed European countries and documents a novel result. While a measure of the convenience yield of government bonds helps explain these spreads, it cannot explain the behavior of bond spreads in periods of widening credit risk. The article documents bond spreads between new and old issues tighten for low-quality sovereigns. In other words, the newer more liquid bonds become cheaper, not more expensive, relative to their older counterparts. We offer an explanation based on price pressure and provide empirical support using data on net flows of investors in sovereign bonds.

Analogous to Stambaugh (1999), this paper derives the small sample bias of estimators in J-horizon predictive regressions, providing a closed-form solution in terms of the sample size, horizon and persistence of the predictive variable. For large J, the bias is linear in JT with a slope that depends on the predictive variable's persistence. The paper offers a number of other useful results, including (i) important extensions to the original Stambaugh (1999) setting, (ii) closed-form bias formulas for popular alternative long-horizon estimators, (iii) out-of-sample analysis with and without bias adjustments, along with new interpretations of out-of-sample statistics, and (iv) a detailed investigation of the bias of the overlapping estimator's standard error based on the methods of Hansen and Hodrick (1980) and Newey and West (1987). The small sample bias adjustments substantially reduce the magnitude of long-horizon estimates of predictability.