The Volcker Rule and Market-Making in Times of Stress

46 Pages Posted: 28 Dec 2016

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: 2016-09

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 stepped in to provide some additional liquidity. 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, the net effect is that bonds are 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 (2016-09). FEDS Working Paper No. 2016-102. Available at SSRN: https://ssrn.com/abstract=2890846 or http://dx.doi.org/10.17016/FEDS.2016.102

Jack Bao (Contact Author)

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

Board of Governors of the Federal Reserve System ( email )

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

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