Customer Liquidity Provision: Implications for Corporate Bond Transaction Costs

56 Pages Posted: 5 Dec 2017

See all articles by Jaewon Choi

Jaewon Choi

University of Illinois at Urbana-Champaign - Department of Finance

Yesol Huh

Board of Governors of the Federal Reserve System - Division of Research and Statistics

Multiple version iconThere are 2 versions of this paper

Date Written: 2017-11-30

Abstract

The convention in calculating trading costs in corporate bond markets is to assume that dealers provide liquidity to non-dealers (customers) and calculate average bid-ask spreads that customers pay dealers. We show that customers often provide liquidity in corporate bond markets, and thus, average bid-ask spreads underestimate trading costs that customers demanding liquidity pay. Compared with periods before the 2008 financial crisis, substantial amounts of liquidity provision have moved from the dealer sector to the non-dealer sector, consistent with decreased dealer risk capacity. Among trades where customers are demanding liquidity, we find that these trades pay 35 to 50 percent higher spreads than before the crisis. Our results indicate that liquidity decreased in corporate bond markets and can help explain why despite the decrease in dealers' risk capacity, average bid-ask spread estimates remain low.

Keywords: Bank regulation, Liquidity, Corporate bond, Financial intermediation, Volcker rule

JEL Classification: G10, G21, G28

Suggested Citation

Choi, Jaewon and Huh, Yesol, Customer Liquidity Provision: Implications for Corporate Bond Transaction Costs (2017-11-30). FEDS Working Paper No. 2017-116. Available at SSRN: https://ssrn.com/abstract=3081747 or http://dx.doi.org/10.17016/FEDS.2017.116

Jaewon Choi (Contact Author)

University of Illinois at Urbana-Champaign - Department of Finance ( email )

1206 South Sixth Street
Champaign, IL 61820
United States

Yesol Huh

Board of Governors of the Federal Reserve System - Division of Research and Statistics ( email )

20th and C Streets, NW
Washington, DC 20551
United States
(202) 973-6943 (Phone)

HOME PAGE: http://sites.google.com/site/yesolhuh

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