Over-the-Counter Market Liquidity and Securities Lending
35 Pages Posted: 16 Nov 2016 Last revised: 19 Apr 2018
Date Written: December 23, 2017
This paper studies how over-the-counter (OTC) market liquidity was adversely affected by the collapse of securities lending during the 2007-2008 financial crisis. We combine micro-data on corporate bond OTC market trades with securities lending transactions, in which life insurance companies are major counterparties. We exploit cross-sectional differences in the corporate bonds that are held and lent by life insurance companies to estimate the causal effect of securities lending on corporate bond market liquidity. We show that the collapse of AIG's securities lending programs in 2008 caused a substantial and long-lasting reduction in the market liquidity of the corporate bonds that were predominantly held by AIG, even after controlling for the interaction between funding liquidity and market liquidity. We find that some of the increase in the illiquidity of bonds held predominantly by AIG can be attributed to a sharp increase in relatively small trades among a greater number of dealers.
Keywords: Over-The-Counter Markets, Corporate Bonds, Market Liquidity, Securities Lending, Insurance Companies
JEL Classification: G01, G12, G22, G23
Suggested Citation: Suggested Citation