Arbitrage and liquidity are interrelated. Liquidity facilitates arbitrageurs’ trading on deviations from the law of one price. However, whether arbitrage opportunity leads to an increase or decrease in liquidity depends on the cause of the deviation. A demand shock leads to greater liquidity,...

This Paper examines the price differences between very liquid on-the-run US Treasury securities and less liquid off-the-run securities over the entire on/off cycle. Unlike previous studies, by comparing pairs of securities as their relative liquidity varies over time, we can disregard any...