Measuring Liquidity Provision by Customers in Corporate Bond Markets: Evidence from 54 Million Transactions
73 Pages Posted: 29 Oct 2019 Last revised: 26 Dec 2019
Date Written: December 24, 2019
This paper measures the time-varying provision of liquidity by buy-side customers (e.g., mutual funds and pension funds), relative to bond dealers, in corporate bond markets using a structural vector autoregression (SVAR) model. As indicated by my simple theory model, shocks to the relative willingness of customers and bond dealers to provide liquidity affect, in opposite directions, the choice of bond dealers between market-making (principal) and matchmaking (riskless principal) transactions. Motivated by this model, my SVAR empirically disentangles these shocks to customers versus bond dealers. My SVAR-derived patterns of these structural shocks provide fundamental insights into the mechanics in corporate bond markets following recent events, such as exposing the increased role of buy-side customers for liquidity provision after the many regulatory changes following the 2008 financial crisis. Furthermore, my empirical approach generates “factors” that provide an improved time-series asset-pricing model for yield spreads of corporate bonds of different credit ratings.
Keywords: corporate bond; customer liquidity provision; structural vector autoregression; sign restrictions
JEL Classification: G12; G14; G24
Suggested Citation: Suggested Citation