My research is in empirical asset pricing, and I have a particular interest in the effects of liquidity, especially in fixed income and money markets. I investigate the determinants of price movements and investors' trades. A better understanding of the drivers of asset prices can help to inform the decisions of policymakers and investors.
  • For instance, I have found that levered investors' demand for very liquid securities is an important contributor to the limits to arbitrage in fixed income markets, allowing pricing anomalies to arise and persist. Investors with relatively short trading horizons also exacerbate relative price differentials between comparable securities.
  • The contribution of market liquidity to euro-area risk spreads varies dramatically by country, separate from the effects of credit. Part of this can be explained by securities' differing liquidity risk premia; some securities benefit from a "flight-to-liquidity" (such as German government bonds) while other securities are shunned in times of poor market conditions.
  • In testing for risk premia, valuable information from the cross-section of individual assets, beyond that found by using portfolios of assets, can increase the precision of estimates.

Research Papers and Some Illustrated Results

The U.S. Treasury yield curve split into two separate curves (liquid versus illiquid securities) in 2008-2009.

Market liquidity differentials between otherwise comparable Treasury securities can have a large effect on the relative prices of these securities. Net funding costs explain only a small fraction of the price divergence when interest rates are low.

Visualizing limits to arbitrage over various holding periods shows that the precise timing of entering into an arbitrage matters more (less) for an investor with a relatively short (long) horizon.

The yield spread between two securities with identical cash flows but different prices is a tradable proxy for market liquidity that can be used to hedge against changes in market liquidity or to interpret changes in risk spreads.

K-Spread Measure of Market Liquidity*
Updated through: October 10, 2017

In the 2007-2009 crisis, euro-area sovereign bond yields showed marked cross-country variation in sensitivity to market liquidity versus credit.
  • On average, German yields show a net decline amid comparable negative shocks to credit and liquidity; the increase in yield attributable to credit is more than offset by a yield decline associated with liquidity.
The risk of future deteriorating market liquidity helps to explain cross-country differences in the importance of liquidity.
  • In times of poor market liquidity, German bonds command a relatively large premium since they benefit from a "flight-to-liquidity" when overall conditions worsen, while Greek, Italian and Portuguese bonds are discounted.
*Schwarz, Krista (2017) "Mind the Gap: Disentangling Credit and Liquidity in Risk Spreads." Working Paper, University of Pennsylvania, Wharton School of Business.

Standard asset pricing models (such as CAPM or Fama-French) give the most precise measures of risk premia if they are estimated with the prices of individual assets rather than portfolios of assets (the larger the portfolio the more estimation efficiency is lost).

Forming portfolios truncates information from the distribution of individual asset "betas" that would otherwise help to pin down the risk premia estimate.

Speculator trades reveal private information in equity futures markets. Hedgers' trades do not.