The Volcker Rule and Market-Making in Times of Stress

50 Pages Posted: 11 Sep 2016 Last revised: 26 Jan 2018

See all articles by Jack Bao

Jack Bao

University of Delaware - Department of Finance

Maureen O'Hara

Cornell University - Samuel Curtis Johnson Graduate School of Management

Xing (Alex) Zhou

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: December 8, 2016

Abstract

Focusing on downgrades as stress events that drive the selling of corporate bonds, we document that the illiquidity of stressed bonds has increased after the Volcker Rule. Dealers regulated by the Rule have decreased their market-making activities while non-Volcker-affected dealers have not offset the decreased activities of Volcker-affected dealers. Furthermore, even Volcker-affected dealers that are not constrained by Basel III and CCAR regulations change their behavior, inconsistent with the effects being driven by these other regulations. Since Volcker-affected dealers have been the main liquidity providers, bonds have become less liquid during times of stress due to the Volcker Rule.

Keywords: Volcker Rule, Corporate Bond Illiquidity, Regulation, Capital Commitment, Dealer Inventory, Market-Making, Financial Crisis

JEL Classification: G14, G21, G23, G24, G28

Suggested Citation

Bao, Jack and O'Hara, Maureen and Zhou, Xing (Alex), The Volcker Rule and Market-Making in Times of Stress (December 8, 2016). Journal of Financial Economics (JFE), Forthcoming; Fourth Annual Conference on Financial Market Regulation. Available at SSRN: https://ssrn.com/abstract=2836714 or http://dx.doi.org/10.2139/ssrn.2836714

Jack Bao

University of Delaware - Department of Finance ( email )

Alfred Lerner College of Business and Economics
Newark, DE 19716
United States

Maureen O'Hara

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Ithaca, NY 14853
United States
607-255-3645 (Phone)
607-255-5993 (Fax)

Xing (Alex) Zhou (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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