Implications for Liquidity from Innovation and Transparency in the European Corporate Bond Market

46 Pages Posted: 12 Aug 2006

See all articles by Marco Laganá

Marco Laganá

European Central Bank (ECB)

Martin Perina

European Central Bank (ECB)

Isabel von Köppen-Mertes

European Central Bank (ECB)

Avinash D. Persaud

affiliation not provided to SSRN

Date Written: August 2006

Abstract

This paper offers a new framework for the assessment of financial market liquidity and identifies two types: search liquidity and systemic liquidity. Search liquidity, i.e. liquidity in normal times, is driven by search costs required for a trader to find a willing buyer for an asset he/she is trying to sell or vice versa. Search liquidity is asset specific. Systemic liquidity, i.e. liquidity in stressed times, is driven by the homogeneity of investors: the degree to which one's decision to sell is related to the decision to sell made by other market players at the same time. Systemic liquidity is specific to market participants' behaviour. This framework proves fairly powerful in identifying the role of credit derivatives and transparency for liquidity of corporate bond markets. We have applied it to the illiquid segments of the European credit market and found that credit derivatives are likely to improve search liquidity as well as systemic liquidity. However, it is possible that in their popular use today, credit derivatives reinforce a concentration of positions that can worsen systemic liquidity. We also found that post-trade transparency has surprisingly little bearing on liquidity in that where it improves liquidity it is merely acting as a proxy for pre-trade transparency or transparency of holdings. We conclude that if liquidity is the objective, pre-trade transparency, as well as some delayed transparency on net exposures and concentrations, is likely to be more supportive of both search and systemic liquidity than post-trade transparency.

Keywords: financial market functioning, liquidity, transparency, credit markets and financial innovation

JEL Classification: G14, G15, G18

Suggested Citation

Laganá, Marco and Perina, Martin and von Köppen-Mertes, Isabel and Persaud, Avinash D., Implications for Liquidity from Innovation and Transparency in the European Corporate Bond Market (August 2006). ECB Occasional Paper No. 50, Available at SSRN: https://ssrn.com/abstract=807427 or http://dx.doi.org/10.2139/ssrn.807427

Marco Laganá (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Martin Perina

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Isabel Von Köppen-Mertes

European Central Bank (ECB) ( email )

Kaiserstrasse 29
D-60311 Frankfurt am Main
Germany

Avinash D. Persaud

affiliation not provided to SSRN

No Address Available

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