Bond Market Illiquidity: Is Portfolio Trading the Solution?
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.
Bond Portfolio Trading, Liquidity, Corporate Bonds, Corporate Bond Dealers, Financial Innovation
SMU Cox: Finance (Topic)