Sovereign Credit Risk, Liquidity, and ECB Intervention: Deus Ex Machina?

66 Pages Posted: 1 Apr 2015 Last revised: 11 Aug 2021

See all articles by Loriana Pelizzon

Loriana Pelizzon

Goethe University Frankfurt - Faculty of Economics and Business Administration

Marti G. Subrahmanyam

New York University (NYU) - Leonard N. Stern School of Business

Davide Tomio

Darden School of Business

Jun Uno

Waseda University

Date Written: March 1, 2015

Abstract

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

Pelizzon, Loriana and Subrahmanyam, Marti G. and Tomio, Davide and Uno, Jun, Sovereign Credit Risk, Liquidity, and ECB Intervention: Deus Ex Machina? (March 1, 2015). Journal of Financial Economics (JFE), Vol. 122, No. 1, 2016, Available at SSRN: https://ssrn.com/abstract=2587786 or http://dx.doi.org/10.2139/ssrn.2587786

Loriana Pelizzon (Contact Author)

Goethe University Frankfurt - Faculty of Economics and Business Administration ( email )

Theodor-W.-Adorno-Platz 3
Frankfurt am Main, D-60323
Germany

Marti G. Subrahmanyam

New York University (NYU) - Leonard N. Stern School of Business ( email )

44 West 4th Street
Suite 9-160
New York, NY NY 10012
United States

Davide Tomio

Darden School of Business ( email )

100 Darden Boulevard
Charlottesville, VA 22903
United States

Jun Uno

Waseda University ( email )

1-6-1 Nishi-Waseda
Shinjuku-ku
Tokyo, 1698050
Japan

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