Friday, Jan. 7, 2022 10:00 AM - 12:00 PM (EST)
- Chair: Burton Hollifield, Carnegie Mellon University
Defragmenting Markets: Evidence from Agency MBS
AbstractAgency MBS issued by Fannie Mae and Freddie Mac have historically traded in separate forward markets. We study the consequences of this fragmentation, showing that market liquidity concentrated in Fannie Mae MBS, reflected in higher trading volume, lower trading costs, a liquidity premium, higher issuance, and higher guarantee fees compared to Freddie Mac. We then analyze a change in market design – the Single Security Initiative – which consolidated the two forward markets in June 2019. Consistent with network externality theories of liquidity, consolidation increased Freddie Mac MBS liquidity together with some improvement for Fannie Mae; this was in part achieved by aligning fundamentals of the MBS issued by these two agencies, mitigating adverse effects of asset heterogeneity.
Customer Liquidity Provision in Corporate Bond Markets: Electronic Trading versus Dealer Intermediation
AbstractWe investigate electronic trading among customers under normal market conditions and during the Covid-19 crisis using a unique data sample of U.S. corporate bond transactions from UBS Bond Port. We show that electronic customer-to-customer (C-to-C) trading is beneficial in terms of costs for orders up to $ 1 million. The advantage of electronic C-to-C trading primarily benefits liquidity-consuming customers, as dealers penalize liquidity takers more than the electronic trading channel. Contrary to expectations, at the onset of the Covid-19 crisis the costs for liquidity takers selling bonds electronically inverted, resulting in negative aggressor markups. We argue that this effect is allocated to the trading protocol of a firm and transparent order book. Volumes in electronic C-to-C trading are more driven by orders wherein the liquidity-consuming party is selling; this effect is amplified in stressed markets. Whereas electronic liquidity provision by dealers is primarily concentrated to normal market conditions, electronic C-to-C trading becomes more important in stressed markets. Literature underestimates the effect of inverting markups during the Covid-19 crisis and thus undervalues electronic C-to-C trading as a viable liquidity pool in stressed markets.
Asset Prices and Liquidity with Market Power and Non-Gaussian Payoffs
AbstractWe consider an economy populated by strategic CARA investors who trade multiple risky assets with arbitrarily distributed payoffs. Our solution method reduces finding the equilibrium to solving a linear ordinary differential equation. With non-Gaussian payoffs: (i) asymmetry and nonlinearity of the price response to order imbalances are linked to higher moments of returns, in line with stylized facts; (ii) liquidity may be reduced when risk aversion or uncertainty decreases; (iii) market illiquidity is proportional to its risk- neutral variance; and (iv) illiquidity of individual assets is proportional to the risk-neutral covariance between returns earned by liquidity providers and asset returns. Empirical results based on option market data are consistent with our key predictions.
- G0 - General