Capital Commitment and Illiquidity in Corporate Bonds
68 Pages Posted: 22 Mar 2016 Last revised: 29 Aug 2017
Date Written: August 28, 2017
We study trading costs and dealer behavior in U.S. corporate bond markets from 2006 to 2016. Despite a temporary spike during the financial crisis, average trade execution costs have not increased notably over time. However, alternative measures, including dealer capital commitment over various time horizons, turnover, block trade frequency, and average trade size not only decreased during the financial crisis, but continued to decline afterward. We find that these declines are attributable to bank-affiliated dealers, as non-bank dealers have increased their market commitment. The evidence shows that liquidity provision in the corporate bond markets is evolving away from the traditional commitment of bank-affiliated dealer capital to absorb customer imbalances, and supports the interpretation that post-crisis banking regulations likely contributed.
Keywords: Capital commitment, corporate bonds, dealer behavior, Dodd-Frank Act, financial crisis, liquidity, microstructure, transparency, TRACE, transaction costs
JEL Classification: G14, G18, G24
Suggested Citation: Suggested Citation