Bond Market Illiquidity: Is Portfolio Trading the Solution?

Authors

Jessica S. Li, University of Chicago - Booth School of BusinessFollow
Maureen O'Hara, Cornell University - Samuel Curtis Johnson Graduate School of ManagementFollow
Andreas C. Rapp, Board of Governors of the Federal Reserve SystemFollow
Xing (Alex) Zhou, Southern Methodist University (SMU) - Finance DepartmentFollow

Publication Date

6-29-2023

Abstract

We examine portfolio trading and its impact on corporate bond liquidity. Our theoretical framework identifies how portfolio trades provide dealers with benefits through a diversification channel and with costs through a balance sheet channel. We then test empirically multiple hypotheses on the countervailing effects of these two channels and find that portfolio trading is generally beneficial to bond market liquidity, particularly so for riskier and illiquid bonds. However, we also show that these positive benefits do not always arise, and that it becomes a costly solution for liquidity provision when markets falter.

Document Type

Article

Keywords

Bond Portfolio Trading, Liquidity, Corporate Bonds, Corporate Bond Dealers, Financial Innovation

Disciplines

Finance

DOI

10.2139/ssrn.4495516

Source

SMU Cox: Finance (Topic)

Language

English