Deviations from no-arbitrage relations should be related to market liquidity, because liquidity facilitates arbitrage. At the same time, a wide futures-cash basis may trigger arbitrage trades and, in turn, affect liquidity. We test these ideas by studying the dynamic relation between stock...

We use the information in credit default swaps to obtain direct measures of the size of the default and nondefault components in corporate spreads. We find that the majority of the corporate spread is due to default risk. This result holds for all rating categories and is robust to the...

This paper shows that all traditional forms of the expectations hypothesis can be consistent with the absence of arbitrage if markets are incomplete. A key implication is that the validity of the expectations hypothesis is purely an empirical issue; the expectations hypothesis cannot be ruled out...

The role that financial innovation plays in financial markets is very controversial. To provide insight into this role, we examine how market participants use the highly successful Treasury STRIPS program. We find that investors use the option to create Treasury-derivative STRIPS primarily to...

Major events often trigger abrupt changes in stock prices and volatility. We study the implications of jumps in prices and volatility on investment strategies. Using the event-risk framework of Duffie, Pan, and Singleton (2000), we provide analytical solutions to the optimal portfolio problem....

Although traded as distinct products, caps and swaptions are linked by no-arbitrage relations through the correlation structure of interest rates. Using a string market model, we solve for the correlation matrix implied by swaptions and examine the relative valuation of caps and swaptions. We...

We study an important recent series of buyback auctions conducted by the U.S. Treasury in retiring $67.5 billion of its illiquid off-the-run debt. The Treasury was successful in buying back large amounts of illiquid debt while suffering only a small market-impact cost. The Treasury included the...

We use the information in collateralized debt obligations (CDO) prices to study market expectations about how corporate defaults cluster. A three-factor portfolio credit model explains virtually all of the time-series and cross-sectional variation in an extensive data set of CDX index tranche...

We conduct an empirical analysis of forward prices in the PJM electricity market using a high-frequency data set of hourly spot and day-ahead forward prices. We find that there are significant risk premia in electricity forward prices. These premia vary systematically throughout the day and are...