Funding Liquidity and Market Liquidity in Government Bonds
Journal of Banking and Finance, Forthcoming
NSE - NYU Stern Initiative Working Paper Series
73 Pages Posted: 7 Mar 2016 Last revised: 26 Apr 2021
Date Written: April 20, 2021
Abstract
Using a comprehensive dataset of orders and trades in the Indian government bond market, this study presents new evidence on the effect of funding liquidity on market liquidity. We find no evidence that lower short-term interest rates - the key instruments of monetary policy - boost market liquidity. However, consistent with models that stress the role of intermediary capital, we find that market liquidity measures have a strong, positive association with short-term borrowing by primary dealers. We provide additional evidence linking these firms' borrowing to their balance sheet strength and secondary market participation. The results suggest that localized funding conditions specific to marginal suppliers of intermediation services are more important for market liquidity than the broader economy-wide funding environment.
Keywords: government bonds, market liquidity, funding liquidity, intermediary capital
JEL Classification: E51, G12, G23
Suggested Citation: Suggested Citation