Corporate Bonds Trading More Certainly Realized at Short Notice: Alternative Models of Market Liquidity

Abstract

Hicks' (1962) definition of liquidity, when assets are "more certainly realizable at short notice without loss", is commonly seen as the bedrock for studies into liquidity of assets. Most studies to date focus on the price premium illiquidity generates, which is an indirect measure that consolidates liquidity's different dimensions. Here we focus directly on the "more certainly realizable" and "at short notice" dimensions, while arguing that the "without loss" dimension is a condition for and not the result of liquidity. In the electronic market for European corporate bonds we estimate the probability of a trade and the time elapsed before a trade occurs following a request-for-quote (RFQ) The major advantage of studying liquidity in this manner is that we disentangle dimensions of liquidity to investigate the liquidity trade-offs that are inherent in trade structuring behavior of dealers and due to responses to RFQs. Some trade aspects will increase trade probability, while slowing down the time-to-trade or vice versa, while other factors consistently in(de-)crease both dimensions. We propose a typology which predicts trade-off effects on liquidity, and specifically focus on the simultaneous effects of dealer behavior in structuring a request-for-quotes when trading through an electronic platform. Empirical results show that dealers' structuring behavior cannot be ignored, but also that response characteristics, which are beyond the influence of dealers have major effects. Given the importance of liquidity in investment decisions we conclude that this study adds fundamental insights into trade outcomes, and implication for electronic trade platforms of corporate bonds and their users.

Keywords: market micro-structure, corporate bonds, liquidity, cure models