Funding Liquidity and Market Liquidity in Government Bonds

Journal of Banking and Finance, Forthcoming

NSE - NYU Stern Initiative Working Paper Series

Indian School of Business

73 Pages Posted: 7 Mar 2016 Last revised: 26 Apr 2021

See all articles by Prachi Deuskar

Prachi Deuskar

Indian School of Business

Timothy C. Johnson

University of Illinois at Urbana-Champaign

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 fi nd that market liquidity measures have a strong, positive association with short-term borrowing by primary dealers. We provide additional evidence linking these fi rms' borrowing to their balance sheet strength and secondary market participation. The results suggest that localized funding conditions speci fic 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

Deuskar, Prachi and Johnson, Timothy C., Funding Liquidity and Market Liquidity in Government Bonds (April 20, 2021). Journal of Banking and Finance, Forthcoming, NSE - NYU Stern Initiative Working Paper Series, Indian School of Business, Available at SSRN: https://ssrn.com/abstract=2740993 or http://dx.doi.org/10.2139/ssrn.2740993

Prachi Deuskar (Contact Author)

Indian School of Business ( email )

Hyderabad, Gachibowli 500 019
India

Timothy C. Johnson

University of Illinois at Urbana-Champaign ( email )

601 E John St
Champaign, IL Champaign 61820
United States

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