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Discussion Paper
Has U.S. Treasury Market Liquidity Deteriorated?
The issue of financial market liquidity has received tremendous attention lately. This partly arises from market participants' concerns that regulatory and structural changes have reduced dealers' market making abilities, but also from events such as the taper tantrum and the flash rally, in which Treasury prices fluctuated sharply amid seemingly little news. But is there really evidence of a sustained reduction in Treasury market liquidity?
Discussion Paper
What's Driving Dealer Balance Sheet Stagnation?
Securities brokers and dealers (“dealers”) engage in the business of trading securities on behalf of their customers and for their own account, and use their balance sheets primarily for trading operations, particularly for market making. Total financial assets of dealers in the United States have not shown any growth since 2009. This stagnation in their balance sheets raises the worry that dealers’ market-making capacity could be constrained, adversely affecting market liquidity. In this post, we investigate the stagnation of dealer balance sheets, focusing particularly on the boom and ...
Discussion Paper
Has Liquidity Risk in the Treasury and Equity Markets Increased?
Market participants have argued that market liquidity has deteriorated since the financial crisis. However, inspection of common metrics such as bid-ask spreads, market depth, and price impact do not show pronounced reductions in liquidity compared with precrisis levels. In this post, we argue that recent changes in liquidity conditions may best be described in terms of heightened liquidity risk, as opposed to general declines in liquidity levels. We propose a measure that shows liquidity risk has risen in equity and Treasury markets and discuss some factors behind the increase.
Discussion Paper
Has Liquidity Risk in the Corporate Bond Market Increased?
Recent commentary suggests concern among market participants about corporate bond market liquidity. However, we showed in our previous post that liquidity in the corporate bond market remains ample. One interpretation is that liquidity risk might have increased, even as the average level of liquidity remains sanguine. In this post, we propose a measure of liquidity risk in the corporate bond market and analyze its evolution over time.
Discussion Paper
Changes in the Returns to Market Making
Since the financial crisis, major U.S. banking institutions have increased their capital ratios in response to tighter capital requirements. Some market analysts have asserted that the higher capital and liquidity requirements are driving up the costs of market making and reducing market liquidity. If regulations were, in fact, increasing the cost of market making, one would expect to see a rise in the expected returns to that activity. In this post, we estimate market-making returns in equity and corporate bond markets to assess the impact of regulations.
Discussion Paper
Redemption Risk of Bond Mutual Funds and Dealer Positioning
Market participants have recently voiced concerns that bond markets seem to become illiquid precisely when they want to sell bonds. Some possible reasons for a decline in corporate bond market liquidity in times of stress include the increasing share of corporate bond ownership by mutual funds and the reduced share of corporate bond ownership by dealers. In this post, we examine the potential effects of outflows from bond mutual funds and the role of dealers? positioning in corporate bonds.
Discussion Paper
Corporate Bond Market Liquidity Redux: More Price-Based Evidence
In a recent post, we presented some preliminary evidence suggesting that corporate bond market liquidity is ample. That evidence relied on bid-ask spread and price impact measures. The findings generated significant discussion, with some market participants wondering about the magnitudes of our estimates, their robustness, and whether such measures adequately capture recent changes in liquidity. In this post, we revisit these measures to more thoroughly document how they have varied over time and the importance of particular estimation approaches, trade size, trade frequency, and the ...
Discussion Paper
Did Third Avenue's Liquidation Reduce Corporate Bond Market Liquidity?
The announced liquidation of Third Avenue’s high-yield Focused Credit Fund (FCF) on December 9, 2015, drew widespread attention and reportedly sent ripples through asset markets. Events of this kind have the potential to increase the demand for market liquidity, as investors revise expectations, reassess risk exposures, and fulfill the need to trade. Moreover, portfolio effects and general fears of contagion may increase the demand for liquidity in assets only remotely related to a liquidating firm’s direct holdings. In this post, we examine whether FCF’s announced liquidation affected ...
Report
Market liquidity after the financial crisis
This paper examines market liquidity in the post-crisis era in light of concerns that regulatory changes might have reduced dealers? ability and willingness to make markets. We begin with a discussion of the broader trading environment, including an overview of regulations and their potential effects on dealer balance sheets and market making, but also considering additional drivers of market liquidity. We document a stagnation of dealer balance sheets after the financial crisis of 2007-09, which occurred concurrently with dealer balance sheet deleveraging. However, using high-frequency trade ...
Report
Global price of risk and stabilization policies
We estimate a highly significant price of risk that forecasts global stock and bond returns as a nonlinear function of the CBOE Volatility Index (VIX). We show that countries? exposure to the global price of risk is related to macroeconomic risks as measured by output, credit, and inflation volatility, the magnitude of financial crises, and stock and bond market downside risk. Higher exposure to the global price of risk corresponds to both higher output volatility and higher output growth. We document that the transmission of the global price of risk to macroeconomic outcomes is mitigated by ...