Post-Crisis Regulations, Trading Delays, and Increasing Corporate Bond Liquidity Premium

Abstract

I propose a supply-based explanation for the increase in the liquidity premium in the corporate bond market after the global financial crisis. I argue that as post-crisis regulations such as Basel II.5 have reduced dealer's provision of immediacy, investors now experience much longer trading delays, and so require a higher liquidity premium than before the crisis. Using a structural over-the-counter model and the publicly available TRACE data, I estimate the unobserved trading delays implied by the size of the liquidity premium. Based on my estimates, bonds that used to be sold within one day now take weeks to trade.

Keywords: Corporate Bond, Liquidity Premium, Trading Delays, Basel II.5

JEL Classification: G10, G12, G18, G20