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Bond Market Liquidity Library
Bali et al, 2018, How and Why Do Corporate Bond Returns Depend on Past Returns? An Empirical Investigation
The cross-section of corporate bond returns strongly depends on past bond returns. Comprehensive transaction-based bond data yield evidence of significant short-term and long-term reversals as well as medium-term momentum in bond returns. The papers provides an illiquidity-based explanation of short-term reversal and show that momentum and long-term reversals are prevalent in the high credit risk sector. Further, long-term reversals occur mainly in downgraded bonds (with low returns), indicating that downgrading increases the risk of holding the bonds, thus increasing the required return. Return-based factors for corporate bonds carry sizable premia and provide strong explanatory power for returns of industry/size/rating/maturity-sorted bond portfolios.

Anand et al, 2018, Do buy-side institutions supply liquidity in bond Markets? Evidence from mutual funds
The paper examines the role of buy-side institutions as liquidity suppliers in bond markets. Focusing on mutual funds, the researchers classify a fund’s trading style as liquidity supplying (demanding) if the fund helps absorb (strain) dealers’ inventory. While mutual funds in aggregate demand liquidity, persistent cross-sectional variation exists – stable funding, family affiliation with dealers, and fund manager skill are associated with liquidity supply. Liquidity supplying trading style earns higher alpha, especially in illiquid markets. The evidence suggests that bond market liquidity can be enhanced by removing institutional frictions that impede broad investor participation in liquidity provision.

Bessembinder et al., 2017, Capital Commitment and Illiquidity in Corporate Bonds
We study trading costs and dealer behavior in U.S. corporate bond markets from 2006 to 2016. Despite a temporary spike during the financial crisis, trade execution costs have not increased notably over time. However, alternative measures, including dealer capital commitment over various time horizons, turnover, block trade frequency, and average trade size not only decreased during the financial crisis, but continued to decline afterward. These declines are attributable to bank-affiliated dealers, as non-bank dealers have increased their market commitment. The evidence supports that liquidity provision in the corporate bond markets is evolving away from the traditional commitment of dealer capital to absorb customer imbalances and toward dealers playing more of a matching role, and that post-crisis regulations focused on banking contributed.

Duffie, D., Zhu, H., 2016, Size Discovery, Forthcoming, Review of Financial Studies, Stanford University Graduate School of Business Research Paper No. 15-56.

Size-discovery mechanisms allow large quantities of an asset to be exchanged at a price that does not respond to price pressure. Primary examples include “workup” in Treasury markets, “matching sessions” in corporate bond and CDS markets, and block-trading “dark pools” in equity markets. By freezing the execution price and giving up on market-clearing, size-discovery mechanisms overcome concerns by large investors over their price impacts. Price-discovery mechanisms clear the market, but cause investors to internalize their price impacts, inducing costly delays in the reduction of position imbalances. We show how augmenting a price-discovery mechanism with a size-discovery mechanism improves allocative efficiency.

Lou, X., Shu, T., 2016, Price Impact or Trading Volume: Why is the Amihud (2002) Illiquidity Measure Priced?
The return premium associated with the Amihud (2002) measure is generally considered a liquidity premium that compensates for price impact. We find that the pricing of the Amihud measure is not attributable to the construction of the return-to-volume ratio that is intended to capture price impact, but driven by the trading volume component. Additionally, the high-frequency price impact and spread benchmarks are priced only in January and do not explain the pricing of the trading volume component of the Amihud measure. Further analyses suggest that the trading volume effect on stock return is due to mispricing, not compensation for illiquidity.

Harris, L., 2015, Transaction costs, trade throughs, and riskless principal trading in corporate bond markets
This study analyzes the costs of trading bonds using previously unexamined quotations data consolidated across several electronic bond trading venues. Much bond market trading is now electronic, but the benefits largely accrue to dealers because their customers often do not trade at the best available prices. The trade through rate is 43%; the riskless principal trade (RPT) rate is above 42%; and 41% of customer trade throughs appear to be RPTs. Average customer transaction costs are 85 bp for retail-size trades and 52 bp for larger trades. Estimated total transaction costs for the year ended March 2015 are above $26 billion, of which about $0.5 billion is due to trade-through value while markups on customer RPTs transfer $0.7 billion to dealers. Small changes in bond market structure could substantially improve bond market quality.

Black J. R., Stock D., and Yadav P. K., 2014, The Pricing of Liquidity Dimensions in Corporate Bonds
Kyle (1985) and Harris (2003) define three dimensions of liquidity – cost, depth, and time. This study is the first to examine the non-default component of corporate bond yield spreads in order to determine the importance of these three dimensions to investors. We find that while illiquidity premia in bonds varies with each individual dimension, the cost dimension is the biggest contributor to illiquidity premia, followed by the time dimension, and lastly, depth. We also examine whether market-wide or only bond-specific liquidity measures affect the value of corporate debt, and find that not only do market-wide liquidity measures affect the value of debt, but they are actually more important than bond-specific measures. Finally, we examine whether the non-default component of yield spreads is comprised solely of the state tax and illiquidity premia.

Dick-Nielsen, J., Feldhütter, P. and Lando, D., 2011, Corporate bond liquidity before and after the onset of the subprime crisis, Journal of Financial Economics, vol. 103, issue 3, pp. 471-492.
This study analyses liquidity components of corporate bond spreads by combining the superior data quality of transaction-level corporate bond prices from TRACE with the increase in bond spreads caused by the crisis. We find that before the crisis, the contribution to spreads from illiquidty was small for investment grade bonds both measured in basis points and as a fraction of total spreads. The contribution increased strongly at the onset of the crisis for all bonds except AAA-rated bonds, which is consistent with a flight-to quality into AAA-rated bonds. Liquidity premia in investment grade bonds rose steadily during the crisis and peaked when the stock market declined strongly in the first quarter of 2009, while premia in speculative grade bonds peaked during the Lehman default and returned almost to pre-crisis levels in mid-2009.

Gabrielsen, A., Marzo, M., and Zagaglia P., 2011, Measuring market liquidity: An introductory survey
Asset liquidity in modern financial markets is a key but elusive concept. A market is often said to be liquid when the prevailing structure of transactions provides a prompt and secure link between the demand and supply of assets, thus delivering low costs of transaction. Providing a rigorous and empirically relevant definition of market liquidity has, however, provided to be a difficult task. This paper provides a critical review of the frameworks currently available for modelling and estimating the market liquidity of assets. We consider definitions that stress the role of the bid-ask spread and the estimation of its components that arise from alternative sources of market friction. In this case, intra-daily measures of liquidity appear relevant for capturing the core features of a market, and for their ability to describe the arrival of new information to market participants.

Bao, J., Pan, J., and Wang, J., 2010, The Illiquidity of Corporate Bonds
This paper examines the illiquidity of corporate bonds and its asset-pricing implications using an empirical measure of illiquidity based on the magnitude of transitory price movements. Relying on transaction-level data for a broad cross-section of corporate bonds from 2003 through 2009, we show that the illiquidity in corporate bonds is substantial, significantly greater than what can be explained by bid-ask spreads. We also find a strong commonality in the time variation of bond illiquidity, which rises sharply during the 2008 crisis. More importantly, we establish a strong link between our illiquidity measure and bond prices, both in aggregate and in the cross-section. In aggregate, we find that changes in the market level of illiquidity explain a substantial part of the time variation in yield spreads of high-rated (AAA through A) bonds.

Goyenko, R.Y., Holden, C.W., and Trzcinka, C.A., 2009, Do liquidity measures measure liquidity? Journal of Financial Economics, vol. 92, pp. 153–181.
Given the key role of liquidity in finance research, identifying high quality proxies based on daily (as opposed to intraday) data would permit liquidity to be studied over relatively long timeframes and across many countries. Using new measures and widely employed measures in the literature, we run horseraces of annual and monthly estimates of each measure against liquidity benchmarks. Our benchmarks are effective spread, realized spread, and price impact based on both Trade and Quote (TAQ) and Rule 605 data. We find that the new effective/realized spread measures win the majority of horseraces, while the Amihud [2002. Illiquidity and stock returns: cross-section and time-series effects. Journal of Financial Markets 5, 31–56] measure does well measuring price impact.

Tian, Y., 2009, Market Liquidity Risk and Market Risk Measurement
The main aim of the thesis is to formulate a concept of liquidity risk and to incorporate market risk measurement with liquidity risk for improvement. To this end, we first review two types of liquidity risk and the relation between liquidity risk and market risk. The thesis is based on a new framework of portfolio theory introduced by Acerbi. According to this formulation, the liquidity of the assets consisting a portfolio is built into the value of that portfolio via a so-called liquidity policy. Under the new framework, the valuation of a portfolio becomes a convex optimization problem. As our own contribution, some examples of calculation schemes for the convex optimization problem are given (see Chapter 5). Equipped with the new portfolio theory, we can quantify market liquidity risk and introduce a new kind of risk measure which includes the impact of liquidity risk.
Citi, 2018, Developments in credit market liquidity
This presentation prepared for the inaugural FIMSAC meeting in January 2018 describes developments in US credit market liquidity from the perspective of macro themes, microstructure, and market structure considerations. It concludes that credit remains a predominantly principal market, that a myriad of influences have led to a loss of heterogeneity, and that it is prudent to focus on building robust infrastructure.

Axa Investment Managers (TSF Fixed Income Trading), 2017, Fixed Income Liquidity: A look back at our historical trading data
A retrospective analysis of our trading data has enabled us to produce this document with information that we believe factual on TSF Trading desk. It is undisputable that market structure has changed along with lower capacity of banks to warehouse bonds due to new regulatory framework and more stringent risk constraints; however, our statistics come challenging the general perception of a major breakdown in corporate bond secondary market and attempt to shade a different light on the matter in line with latest reports, published end of August 2016, from ESMA and IOSCO.

Federal Reserve Bank of New York, 2017, Dealer Balance Sheets and Bond Liquidity Provision
Do regulations decrease dealer ability to intermediate trades? Using a unique data set of dealer bond-level transactions, we link changes in liquidity of individual U.S. corporate bonds to dealers’ transaction activity and balance sheet constraints. We show that, prior to the financial crisis, bonds traded by more levered institutions and institutions with investment-bank-like characteristics were more liquid but this relationship reverses after the financial crisis. In addition, institutions that face more regulations after the crisis both reduce their overall volume of trade and have less ability to intermediate customer trades.

ESRB, 2016, Market liquidity and market-making
There is a significant information gap in terms of financial reporting in the EU that hampers a full assessment of the level of market liquidity and any related systemic risks. This report contributes to the debate on market liquidity conditions by providing new evidence, in particular on market-making activities. The data provide a mixed picture with the results varying by asset market and the market liquidity indicator used. For asset classes other than corporate bonds, gross and net inventories have either increased or remained unchanged. However, for European corporate bond markets, gross and net inventories have declined since 2010, possibly indicating a reduced ability or willingness of market-makers to act as intermediaries in these markets.

Vanguard, 2016, Innovation and evolution in the fixed income market
At first blush, it may appear as though the fixed income market is less liquid than it has been in the past. Corporate bond markets have grown considerably over the last several years, just as dealers’ appetite to hold bonds in inventory to facilitate trades has diminished. This shift in dynamics, though undeniable, is not a harbinger of doom, nor is it the end of the story. Rather, it’s the beginning of a new chapter that highlights the resiliency of the financial markets and the imagination of many of its participants. The market and its participants are doing what they always do – adapting, innovating, and evolving.

CFA Institute, 2016, Secondary Corporate Bond Market Liquidity Survey Report
To inform policy developments related to bond market liquidity, CFA Institute conducted a survey of a pool of its members across the globe that have expressed interest and expertise in this topic. Respondents from the Americas region and EMEA report that over the last five years they have observed (i) a decrease in the liquidity of high‐yielding and investment‐grade corporate bonds and no change in the liquidity of government bonds; (ii) a decrease in the number of active dealers making markets; (iii) an increase in the time taken to execute trades and a lower proportion of bonds being actively traded; (iv) a higher proportion of unfilled orders. These respondents also noted that bank capital and liquidity regulations have had a significant impact on bond market liquidity and that the focus of policymakers should be on removing impediments to the smooth functioning of institutional wholesale markets.

ISDA, 2016, Single-name Credit Default Swaps: A Review of the Empirical Academic Literature
Single-name credit default swaps (“CDSs”) are derivatives based on the credit risk of a single borrower such as a corporation or sovereign. Although the single-name CDS market expanded rapidly during the period of loose monetary policy and expanding credit from 2002 through 2007, its growth began to slow after the global credit crisis and during the Eurozone sovereign debt crisis in 2010 and 2011, after which the single-name CDS market began to contract. In recent years and despite deliberate efforts by the International Swaps and Derivatives Association (ISDA) and market participants on both the buy and sell sides, the single-name CDS market shifted from stagnating growth to an actual contraction and has shrunk substantially.

BlackRock, 2016, Addressing Market Liquidity: A broader perspective on today’s Euro corporate bond market, ViewPoint August 2016
This ViewPoint is a continuation of previous BlackRock publications addressing market liquidity and the ownership of the world’s financial assets, focusing specifically on euro denominated debt, including corporate bonds. It highlights several aspects of the Euro corporate bond market that have been missing from the dialogue including: (i) The diversity of asset owners, each with unrelated objectives and constraints that result in different investment behaviours in response to changing market conditions. (ii) Built-in demand for bonds as Central Banks, insurers, and some pension funds must reinvest dividends and principal to keep balance sheet assets invested, in addition to potential demand from insurers and pension funds seeking higher yields when interest rates rise. (iii) Gradual shift from loans to bonds in euro area compensates for the reduced capacity of banks to provide financing.

Vanguard, 2016, Clear perspectives on bond market liquidity
Since the global financial crisis, new regulations and low interest rates have led to changes in the bond market. This has raised concerns that in periods of market stress, bond fund investors will panic and redeem their shares. Mutual funds would then struggle to find the liquidity to convert their holdings into cash. Our experience suggests reasons for optimism about the bond market’s ability to match buyers and sellers as different needs arise. Liquidity is dynamic. It has a price that changes with market conditions. Participants in large, broadly diversified markets consistently manage to find a market-clearing price for high-quality securities.

BIS, 2016, Hanging up the phone – electronic trading in fixed income markets and its implications, Quarterly Review, March 2016
This article explores drivers and implications of the rising use of electronic and automated trading in fixed income markets – a process we refer to as “electronification”. We take stock of the current state of electronic trading and how it has changed the market ecosystem, its resilience and its overall functioning. Trading in fixed income markets is becoming more automated as electronic platforms explore new ways to bring buyers and sellers together. In the most liquid markets, traditional dealers are increasingly competing with new market participants whose trading strategies rely exclusively on sophisticated computer algorithms and speed. Some dealers, in turn, have embraced automated trading to provide liquidity to customers at lower costs and with limited balance sheet exposure.

BIS (Markets Committee), 2016, Electronic trading in fixed income markets
Electronic trading in fixed income markets has been growing steadily. In many jurisdictions, it has supplanted voice trading as the new standard for many fixed income asset classes. Electronification, ie the rising use of electronic trading technology, has been driven by a combination of factors. These include: (i) advances in technology; (ii) changes in regulation; and (iii) changes in the structure and liquidity characteristics of specific markets. This report highlights two specific areas of rapid evolution in fixed income markets. First, trading is becoming more automated in the most liquid and standardised parts of fixed income markets, often importing technology developed in other asset classes. Second, electronic trading platforms are experimenting with new protocols to bring together buyers and sellers.

BIS, 2016, Fixed income market liquidity, CGFS Papers, no. 55
The report highlights that fixed income markets are in a state of transition. Dealers have continued to cut back their market-making capacity in many jurisdictions. Demand for market-making services, in turn, continues to grow. The effects of these diverging trends have, thus far, not manifested themselves in the price of immediacy services, but rather they are reflected in possibly increasingly fragile liquidity conditions. Key drivers of current trends in liquidity include the expansion of electronic trading, dealer deleveraging, arguably reinforced by regulatory reform, and unconventional monetary policies. Given the transitional state of fixed income markets, regulators appear to be facing a short-term trade-off between less risk-taking by banks and more resilient market liquidity. Yet, in the medium term, measures to bolster market intermediaries’ risk-absorption capacity will strengthen systemic stability, including through a more sustainable supply of immediacy services.

BlackRock, 2016, Addressing Market Liquidity: A Broader Perspective on Today’s Bond Markets, ViewPoint February 2016
The data shows that bond markets are undergoing a structural change to liquidity: (1) Broker-dealer inventories have declined as dealers reduce balance sheet risk; (2) Bond turnover (trading volume as currently measured divided by outstanding debt) has declined; (3) Record corporate bond issuance reflects cheap money. However, this is only a partial picture of the current fixed income ecosystem: (1) Many asset owners have unrelated objectives and constraints that drive their behavior in disparate ways; (2) While bond ownership by open-end mutual funds and ETFs has grown, the majority of fixed income assets are owned by other types of asset owners; (3) Liquidity is not “free”: the cost of liquidity can increase when immediacy is needed or when market liquidity is scarce; (4) Market participants are adapting to changes in market liquidity and regulators are addressing liquidity risk management; (5) Bond turnover data omits critical elements of today's bond market structure. The growth of bond ETFs and secondary market trading of bond ETF shares are important new developments.

Vanguard, 2016, Innovation and evolution in the fixed income market
The paper identifies several key improvements to help electronic trading continue to evolve in ways that are most beneficial to investors. It advocates for policies and practices that (i) limit the fragmentation of trading, (ii) encourage direct interaction between buyers and sellers, (iii) better link trading and order-management systems, (iv) provide greater price transparency, and (v) protect against information leakage.

AllianceBernstein, 2016, Playing With Fire – The Bond Liquidity Crunch And What To Do About It
The paper attempts to explain what is behind the so-called ‘liquidity drought’, what investors can do to protect themselves, and, potentially, profit. It suggests that successful investing should not rely solely on liquidity, and that those who can ‘keep their cool’ amidst declining liquidity can be profitable.

IMF, 2015, Market Liquidity – Resilient or Fleeting? Global Financial Stability Report: Vulnerabilities, Legacies, and Policy Challenges: Risks Rotating to Emerging Markets, pp. 49-82.
This chapter explores developments in market liquidity and the role of liquidity drivers, with a focus on bond markets (Table 2.5). Structural changes, such as reductions in market making, appear to have reduced the level and resilience of market liquidity. Changes in market structures—including growing bond holdings by mutual funds and a higher concentration of holdings—appear to have increased the fragility of liquidity. At the same time, the proliferation of small bond issuances has likely lowered liquidity in the bond market and helped build up liquidity mismatches in investment funds. Standardization and enhanced transparency appear to improve securities liquidity.

PWC, 2015, Global financial markets liquidity study
The study finds specific areas where market liquidity has declined, and warning signs that more significant declines may be masked by other factors. These include: (i) Difficulties in executing trades: Market participants are still generally able to execute the trades they require, but the time taken and effort required to execute both with dealers and across multiple platforms has increased. (ii) Reduction in market depth: There are signs of declining depth and immediacy in capital markets as characterised by falling transaction sizes. (iii) Increase in volatility: There is evidence that episodes of market correction and volatility are now rising, after falling considerably since the global financial crisis. Volatility in bond markets in 2015 is around 40% higher than in 2014. (iv) Bifurcation in liquidity: There is market evidence to suggest that a “bifurcation” is taking place across some markets. Liquidity is increasingly concentrating in the more liquid instruments and falling in less liquid assets.

BIS, 2014, Market-making and proprietary trading: industry trends, drivers and policy implications, CGFS Papers, no. 52
This report presents the Group’s findings. It identifies signs of increased liquidity bifurcation and fragility, with market activity concentrating in the most liquid instruments and deteriorating in the less liquid ones. Drivers are both conjunctural and structural in nature, and it remains difficult at this stage to provide a definitive overall assessment. Yet, given signs that liquidity risks were broadly underpriced in the run-up to the financial crisis, it seems likely that the compressed pricing of immediacy services observed in the past will give way to liquidity premia more consistent with actual market-making capacity and costs. The report outlines a number of possible policy implications that, if pursued, would help making this outcome more likely and would support the robustness of market liquidity.
ESMA, 2018, Liquidity in fixed income markets – risk indicators and EU evidence
The paper finds that market liquidity has been relatively ample in the sovereign segment, potentially also due to the effects of supportive economic policies over more recent years. Meanwhile, the researchers also fail to find a systematic and significant drop in market liquidity in the corporate bond market in recent years, however, they do observe episodes of decreasing market liquidity when market conditions have deteriorated. Building on an econometric analysis to investigate the drivers of market liquidity in these markets, the researchers find that in the sovereign bond segment, bonds that have a benchmark status and are characterized by larger outstanding amounts tend to be more liquid while market volatility is negatively related to market liquidity. Outstanding amounts are the main bond-level drivers in the corporate bond segment. Moreover, in both segments, overall stressed financial markets conditions seem to be related to lower market liquidity in fixed income markets. Results hold when different samples (in terms of geography, maturity and market liquidity volatility) are taken into account in sovereign bond and corporate bond markets. With reference to corporate bond markets, the sensitivity of bond liquidity to bond-specific and market factors is larger when financial markets are under stress. In particular, bonds characterized by more volatile market liquidity are found to be more vulnerable in periods of market stress. This empirical result is consistent with the market liquidity indicators developed for corporate bonds pointing at episodes of decreasing market liquidity when wider market conditions deteriorate.

FCA, 2017, New evidence on liquidity in UK corporate bond markets

Using not only standard measures of liquidity but also measures of dealers’ ease of trading, we find there has been a decline in liquidity from mid-2014 onward. However, from a long-term perspective this reduction in liquidity appears moderate. Previous research conducted by the Chief Economist’s Department for the period 2008-2014, as well as reports by FINRA, the AMF and IOSCO covering similar time periods, found little evidence of a quantifiable deterioration in liquidity. In this note, we update our study by extending our analysis to include the period after 2014, as well as incorporating new data about orders and quotes. Our findings suggest […] that trading conditions have become somewhat more difficult over the past 18-24 months. Market participants may have to work harder today to complete a trade than in previous years.

IOSCO, 2017, Examination of Liquidity of the Secondary Corporate Bond Markets: Final Report
IOSCO conducted a study of the liquidity of the secondary corporate bond markets in IOSCO Committee 2 member jurisdictions, including the impact of structural and regulatory developments since 2004, with a particular focus on the period just prior to the financial crisis to 2015. Analysis of the data collected from IOSCO Committee 2 members regarding the corporate bond markets in their respective jurisdictions was challenging because of differences in data collection methods and scope, quality, consistency and availability. These differences made it difficult to aggregate and compare data across jurisdictions. Based on the totality of information collected and analysed, IOSCO did not find substantial evidence showing that liquidity in the secondary corporate bond markets has deteriorated markedly from historic norms for non-crisis periods.

FCA, 2016, Liquidity in the UK corporate bond market: evidence from trade data, Occasional Paper 14
We present evidence on the evolution of liquidity in the UK corporate bond market for the period 2008–2014. On the basis of a series of widely accepted liquidity measures, we document that there is no evidence that liquidity outcomes have deteriorated in the market, despite the decline in inventory of dealers in this period. If anything, the market appears to have become more liquid in recent years. We also document that there is little evidence that liquidity is having a larger effect on bond spreads now than a few years ago. We do not find evidence that liquidity has become more ‘flighty’ in response to shocks of a mild to moderate nature, as measures of liquidity risk do not increase over the period of analysis. However, we do not claim that there are no risks associated with liquidity. Our own analysis shows that liquidity is subject to considerable deterioration if the market is under severe stress; there was considerably less liquidity in 2009/10 than either before or after this period.

AMF, 2015, Study of liquidity in French bond markets
At a time when some participants are considering regulations as a constraint that has caused liquidity to dry up, this article describes the first findings of an AMF analysis on liquidity in French bond markets between 2005 and 2015. Based on trade data received by the AMF and bid-ask spreads data, a composite liquidity indicator was constructed. The results suggest that, after the two episodes of strong decline due to 2007-2009 and 2011 crisis, liquidity has improved steadily in French bond markets since the beginning of 2012 albeit without recovering its pre-crisis level (2005-2007). Liquidity also tends to be more concentrated in instruments that are either least risky or that offer the greatest market depth. However, this improvement of bond markets liquidity does not signify resilience in the event of shocks. This paper is a first presentation of the AMF analysis on bond markets liquidity and constitutes a work in progress.