Bond Market Illiquidity: Is Portfolio Trading the Solution?

This paper subsumes Li (2022) "Frictional Intermediation, Inventory Hedging, and the Rise of Portfolio Trading in the Corporate Bond Market" (https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4053987)

SMU Cox School of Business Research Paper No. 23-09

60 Pages Posted: 3 Jul 2023

See all articles by Jessica S. Li

Jessica S. Li

University of Chicago - Booth School of Business

Maureen O'Hara

Cornell University - Samuel Curtis Johnson Graduate School of Management; Cornell SC Johnson College of Business

Andreas C. Rapp

Board of Governors of the Federal Reserve System

Xing (Alex) Zhou

Southern Methodist University (SMU) - Finance Department

Multiple version iconThere are 2 versions of this paper

Date Written: June 29, 2023

Abstract

We examine portfolio trading and its impact on corporate bond liquidity. Our theoretical framework identifies how portfolio trades provide dealers with benefits through a diversification channel and with costs through a balance sheet channel. We then test empirically multiple hypotheses on the countervailing effects of these two channels and find that portfolio trading is generally beneficial to bond market liquidity, particularly so for riskier and illiquid bonds. However, we also show that these positive benefits do not always arise, and that it becomes a costly solution for liquidity provision when markets falter.

Keywords: Bond Portfolio Trading, Liquidity, Corporate Bonds, Corporate Bond Dealers, Financial Innovation

JEL Classification: G01, G10, G12, G20, G23, G24

Suggested Citation

Li, Jessica S. and O'Hara, Maureen and Rapp, Andreas C. and Zhou, Xing (Alex), Bond Market Illiquidity: Is Portfolio Trading the Solution? (June 29, 2023). This paper subsumes Li (2022) "Frictional Intermediation, Inventory Hedging, and the Rise of Portfolio Trading in the Corporate Bond Market" (https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4053987), SMU Cox School of Business Research Paper No. 23-09, Available at SSRN: https://ssrn.com/abstract=4495516 or http://dx.doi.org/10.2139/ssrn.4495516

Jessica S. Li (Contact Author)

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
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)

Cornell SC Johnson College of Business ( email )

Ithaca, NY 14850
United States

Andreas C. Rapp

Board of Governors of the Federal Reserve System ( email )

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

HOME PAGE: http://https://www.federalreserve.gov/econres/andreas-c-rapp.htm

Xing (Alex) Zhou

Southern Methodist University (SMU) - Finance Department ( email )

United States

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