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Financial market imperfections and their asset pricing implications

This thesis consists of two studies on financial
market imperfections. The first study (Chapters 2 and 3)
investigates illiquidity, which is a reflection of different
imperfections, and its pricing implications in the corporate bond
market. The second study (Chapter 4) evaluates the impact of a
short-sale ban, which is a form of financial constraints, on the
equity and derivatives markets. In Chapter 2, we propose
illiquidity measures that outperform existing ones statistically
and economically. We estimate various illiquidity measures in the
corporate bond market, using transaction-level data from 2002 to
2010. In the cross-section, we find illiquidity measures to be
related to bond characteristics often used as illiquidity proxies.
In the time-series, we show commonality in the aggregate
illiquidity measures, increasing during the sub-prime crisis and
peaking in October 2008. We then identify that time variation in
aggregate illiquidity measures is linked with market variables such
as the VIX index. In Chapter 3, we examine pricing implications of
the illiquidity measures. We find that illiquidity level is priced
both at the aggregate level and at the bond level throughout the
sample period. However, the role of illiquidity risk in pricing
bond yield spreads is weaker, and is driven by the 2008 financial
crisis. In Chapter 4, we study the 2008 short-sale ban. We find
that the banned stocks have positive cumulative abnormal returns
and become more volatile when the ban is imposed. We document
greater demand and abnormalities in the futures market and option
market under the short-sale ban. This evidence suggests that a
short-sale ban may not stabilize a financial market in
crisis.