Sovereign Credit Risk, Liquidity, and ECB Intervention: Deus Ex Machina?
SAFE Working Paper No. 95
66 Pages Posted: 1 Apr 2015 Last revised: 17 Apr 2019
Date Written: March 2015
We examine the dynamic relation between credit risk and liquidity in the Italian sovereign bond market during the Euro-zone crisis and the subsequent European Central Bank (ECB) interventions. Credit risk drives the liquidity of the market: a 10% change in the credit default swap (CDS) spread leads to a 13% change in the bid-ask spread, the relation being stronger when the CDS spread exceeds 500 bp. The Long-Term Refinancing Operations (LTRO) of the ECB weakened the sensitivity of market makers’ liquidity provision to credit risk, highlighting the importance of funding liquidity measures as determinants of market liquidity.
Keywords: Liquidity, Credit Risk, Euro-zone Government Bonds, Financial Crisis, MTS Bond Market
JEL Classification: G01, G12, G14
Suggested Citation: Suggested Citation