How Safe Was the 'Safe Haven'? Financial Market Liquidity During the 1998 Turbulences

Abstract

The secondary market for four German benchmark government bonds experienced a notable reduction in liquidity in the wake of the Russian devaluation on August 17th, 1998 as well as a surge in the volatility of yields and a widening in the yield spread between the individual bonds. The increase in the cost of trading, as measured by the effective spread, cannot be explained by surprises in trading volume, which indicates that private information did not play a major role during this episode. The fact that the market was able to handle a statistically significantly higher than usual number of transactions and turnover. In this sense, liquidity provision has been remarkably effective in dealing with the turbulences.

JEL Classification: G14