This paper establishes liquidity linkage between stock and Treasury bond markets. There is a lead-lag relationship between illiquidity of the two markets and bidirectional Granger causality. The effect of stock illiquidity on bond illiquidity is consistent with flight-to-quality or flight-to-liquidity episodes. Monetary policy impacts illiquidity. The evidence indicates that bond illiquidity acts as a channel through which monetary policy shocks are transferred into the stock market. These effects are observed across illiquidity of bonds of different maturities and are especially pronounced for illiquidity of short-term maturities. The paper provides evidence of illiquidity integration between stock and bond markets.

Previous empirical studies on the “rationality” of economic and financial forecasts generally test for generic properties such as bias or autocorrelated errors but provide only limited insight into the behavior behind inefficient forecasts. This paper tests for a specific form of forecast bias. In particular, we examine whether expert consensus forecasts of monthly economic releases are systematically biased toward the value of previous months’ releases. Such a bias would be consistent with the anchoring and adjustment heuristic described by Tversky and Kahneman (1974) or could arise from professional forecasters’ strategic incentives. We find broad-based and significant evidence for this form of bias, which in some cases results in sizable predictable forecast errors. To investigate whether market participants’ expectations are influenced by this bias, we examine interest rate reactions to economic news. We find that bond yields react only to the residual, or unpredictable, component of the forecast error and not to the component induced by anchoring, suggesting that expectations of market participants anticipate this bias embedded in expert forecasts.

In 12 sessions conducted in a typical bubble-generating experimental environment, we design a pair of assets that can detect both irrationality and speculative behavior. The specific form of irrationality we investigate is the probability judgment error associated with low-probability, high-payoff outcomes. Independently, we test for speculation by comparing prices of identically paying assets in multiperiod versus single-period markets. We establish that aggregate irrationality measured in one dimension (probability judgment error) is associated with aggregate irrationality measured in another (bubble formation).

In 12 sessions conducted in a typical bubble-generating experimental environment, we design a pair of assets that can detect both irrationality and speculative behavior. The specific form of irrationality we investigate is the probability judgment error associated with low-probability, high-payoff outcomes. Independently, we test for speculation by comparing prices of identically paying assets in multiperiod versus single-period markets. We establish that aggregate irrationality measured in one dimension (probability judgment error) is associated with aggregate irrationality measured in another (bubble formation).