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Liquidity

Paper Session

Friday, Jan. 7, 2022 10:00 AM - 12:00 PM (EST)

Hosted By: American Finance Association
  • Chair: Burton Hollifield, Carnegie Mellon University

Financial Intermediaries Market Power and Asset Prices in Treasury Securities

Sudip Gupta
,
Johns Hopkins University

Abstract

In this paper, we analyze the effect of competition on the liquidity provision by the primary dealers in the treasury market. We analyze this issue using a unique dataset in a novel setting of entry of a new primary dealer (Goldman Sachs). In both reduced form and structural estimation setting we find that all the primary dealers improve the liquidity provision in terms of lower bid-shading after the entry of Goldman Sachs. Using a structural model of strategic bidding behavior under asymmetric information, we find that the liquidity provision as measured by (lower) bid-shading by the primary dealers improve by about 5 basis points, equivalent to about INR 20 million per auction.

Defragmenting Markets: Evidence from Agency MBS

Haoyang Liu
,
Federal Reserve Bank of New York
Zhaogang Song
,
Johns Hopkins University
James Vickery
,
Federal Reserve Bank of Philadelphia

Abstract

Agency mortgage-backed securities (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 endogenously concentrated in Fannie Mae MBS, leading to higher issuance and trading volume, lower transaction costs, higher security prices and a lower primary market cost of capital for Fannie Mae. We then analyze a change in market design -- the Single Security Initiative -- which consolidated Fannie Mae and Freddie Mac MBS trading into a single market in June 2019. We find that consolidation increased the liquidity of Freddie Mac mortgage bonds, without significantly reducing liquidity for Fannie Mae; this was in part achieved by aligning characteristics of the underlying MBS pools issued by the two agencies. Prices partially converged prior to the consolidation event, in anticipation of future liquidity. Consolidation increased Freddie Mac's fee income by enabling them to remove discounts that previously compensated loan sellers for lower liquidity.

Customer Liquidity Provision in Corporate Bond Markets: Electronic Trading versus Dealer Intermediation

Brian Mattmann
,
University of Basel

Abstract

We 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

Sergei Glebkin
,
INSEAD
Semyon Malamud
,
Swiss Federal Institute of Technology-Lausanne (EPFL)
Alberto Teguia
,
University of British Columbia

Abstract

We 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.
Discussant(s)
Pietro Bonaldi
,
Carnegie Mellon University
Nils Friewald
,
Norwegian School of Economics
Norman Schuerhoff
,
University of Lausanne
Michael Gallmeyer
,
University of Virginia
JEL Classifications
  • G0 - General