Implications for Liquidity from Innovation and Transparency in the European Corporate Bond Market
46 Pages Posted: 12 Aug 2006
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: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Explaining the Rate Spread on Corporate Bonds
By Edwin J. Elton, Martin J. Gruber, ...
-
The Determinants of Credit Spread Changes
By Pierre Collin-dufresne, J. Spencer Martin, ...
-
How Much of Corporate-Treasury Yield Spread is Due to Credit Risk?
By Jing-zhi Huang and Ming Huang
-
How Much of the Corporate-Treasury Yield Spread is Due to Credit Risk?
By Jing-zhi Huang and Ming Huang
-
How Much of the Corporate-Treasury Yield Spread is Due to Credit Risk?
By Jing-zhi Huang and Ming Huang
-
Corporate Yield Spreads: Default Risk or Liquidity? New Evidence from the Credit-Default Swap Market
By Francis A. Longstaff, Sanjay Mithal, ...
-
Equity Volatility and Corporate Bond Yields
By John Y. Campbell and Glen B. Taksler
-
Equity Volatility and Corporate Bond Yields
By John Y. Campbell and Glen B. Taksler
-
Structural Models of Corporate Bond Pricing: An Empirical Analysis
By Young Ho Eom, Jing-zhi Huang, ...
-
By Roberto Blanco, Simon Brennan, ...