Bond Liquidity Premia

Review of Financial Studies, (2012) 25 (4):1207-1254

EFA 2009 Bergen Meetings Paper

60 Pages Posted: 1 Mar 2007 Last revised: 22 Nov 2012

See all articles by Jean-Sebastien Fontaine

Jean-Sebastien Fontaine

Bank of Canada

René Garcia

Université de Montréal ; Toulouse School of Economics

Date Written: June 30, 2009


Asset pricing models of limits to arbitrage emphasize the role of funding conditions faced by financial intermediaries. In the US, the Treasury repo market is the key funding market and, hence, theory predicts that the liquidity premium of Treasury bonds share a funding liquidity component with risk premia in other markets. We identify and measure the value of funding liquidity from the cross-section of bonds by adding a liquidity factor correlated with age to an arbitrage-free term structure model. We validate our interpretation of this funding liquidity factor by establishing its linkages with other measures of funding conditions at three different levels of aggregation. Looking at asset pricing implications, we find that an increase in the value of liquidity predicts lower risk premia for on-the-run and off-the-run bonds but higher risk premia on LIBOR loans, swap contracts and corporate bonds. The impact is large and pervasive through crisis and normal times. Conditions on funding markets have a first-order impact on interest rates.

Keywords: Bond Prices, Term Structure, Funding Liquidity

JEL Classification: E43, H12

Suggested Citation

Fontaine, Jean-Sebastien and Garcia, René, Bond Liquidity Premia (June 30, 2009). Review of Financial Studies, (2012) 25 (4):1207-1254, EFA 2009 Bergen Meetings Paper, Available at SSRN: or

Jean-Sebastien Fontaine (Contact Author)

Bank of Canada ( email )

234 Wellington Street
Ontario, Ottawa K1A 0G9


René Garcia

Université de Montréal ( email )

C.P. 6128, succursale Centre-Ville
3150, rue Jean-Brillant, bureau C-6027
Montreal, Quebec H3C 3J7
514-7018807 (Phone)

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Toulouse School of Economics ( email )


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