A heterogeneous agents equilibrium model for the term structure of bond market liquidity

We analyze the impact of market frictions on trading volume and liquidity premia of finite maturity assets when investors differ in their trading needs. Our equilibrium model generates a clientele effect (frequently trading investors only hold short-term assets) and predicts i) a hump-shaped relation between trading volume and maturity, ii) lower trading volumes of older compared to younger assets, iii) an increasing liquidity term structure from ask prices, iv) a decreasing or U-shaped liquidity term structure from bid prices, and v) spill-overs of liquidity from short-term to long-term maturities. Empirical tests for U.S. corporate bonds support our theoretical predictions.