Recent studies on the US corporate and emerging market sovereign bond market show that a sizable component of emerging market sovereign yield spreads is due to factors other than default risk (Chen, Lesmond, and Wei (2007), Collin-Dufresne and Martin (2001), Huang and Huang (2003), Kucuk (2008)). Liquidity, the ability of investors to buy or sell large quantities of securities quickly at low cost and without substantially influencing the price, is found to be a plausible explanation for the variations in yield spreads across di erent bonds (Kucuk (2008), Ferrucci (2003), Duffie, Pedersen, and Singleton (2003), and Beber, Brandt, and Kavajecz (2006)).
There is extensive research on the determinants of corporate bond yields and their relationship with liquidity, however there is not much evidence on the time series variation of liquidity of bonds especially for those of internationally traded sovereigns bonds. It has been shown that for sovereign bonds, the world market and the macroeconomic shocks play important role in determining their yield spreads.Therefore, this paper analyzes the time-series and cross-section variation in aggregate liquidity and the e ffects of market-wide variables and macroeconomic fundamentals on sovereign bond liquidity.
The studies by Chordia, Roll, and Subrahmanyam (2000) and Chordia, Roll, and Subrahmanyam (2001) identi ed the concept of liquidity commonality. Their results have introduced research on the eff ects of market-wide liquidity. Indeed, Pastor and Stambaugh (2002) and Acharya and Pedersen (2005) found some evidence that the variation in aggregate liquidity is indeed an important factor in explaining the cross section of stock returns as well as the time-series of aggregate returns (Amihud (2002) and Bekaert, Harvey, and Lundblad (2006). Fujimoto (2004) using a long time-span data set finds that macroeconomic sources play important role in determining the the time-series variation in the US stock market liquidity. Studies including Chordia (2005) and Goyenko and Ukhov (2009) go one step further to analyze the joint dynamics of US stock and US Treasury bond market liquidity.