Notes on Bonds: Illiquidity Feedback During the Financial Crisis
52 Pages Posted: 1 Jul 2015 Last revised: 30 Dec 2017
Date Written: December 29, 2017
We trace the evolution of extreme illiquidity discounts among Treasury securities during the financial crisis, when bond prices fell more than six percent below more-liquid but otherwise identical notes. Using high-resolution data on market quality and trader identities and characteristics, we find that the discounts amplify through feedback loops, where cheaper, less-liquid securities flow to investors with longer horizons, thereby increasing their illiquidity and thus their appeal to these investors. The effect of the widened liquidity gap on transactions costs is further amplified by a surge in the price liquidity providers charge for access to their balance sheets in the crisis.
Keywords: liquidity, feedback, Treasury market, financial crisis, limits to arbitrage, repo
JEL Classification: E43, G12, G14, G22
Suggested Citation: Suggested Citation