This paper aims to answer the question of whether post-crisis regulatory interventions caused a decline in liquidity. To serve this purpose, it investigates how individual provisions affect the market making business and how the corporate bond market changed in response to regulations. The paper approaches the issue by structuring theoretical and empirical evidence of corporate bond liquidity. It develops regulations impact levels from particular to aggregate, facilitating a perspicacious analysis. Important to note, the study attempts to assess neither welfare effects nor the desirability of regulations.
After the financial crisis, regulators intervened to enhance the resilience of the banking system. Their provisions range from capital and liquidity standards to the prohibition of single activities considered too risky. However, concerns arise that post-crisis regulations harm liquidity by imposing constraints on its providers. When liquidity is low, investors that want to trade large volumes must wait for counterparties or accept to trade below market prices. Therefore, in certain financial markets like that for corporate bonds, intermediaries emerged to facilitate market functioning. They enable investors to trade immediately, reconciling imbalances in supply and demand.
Illiquidity is costly for the economy as investors require compensation for holding riskier bonds. Amihud and Mendelson provide cross-sectional and time-series evidence of the resulting illiquidity discount. Hence, if regulations reduced liquidity, they would cause a depreciation of prices. Also, lower liquidity implies higher cost of debt and transaction costs, as well as a less efficient resource allocation. The regulatory impact on liquidity is, therefore, highly important for policymakers and investors.
Table of Content
List of Abbreviations
List of Figures
1. Introduction
2. Liquidity provision in equity and corporate bond markets
2.1. Equity markets
2.2. Corporate bond markets
3. Post-crisis regulatory provisions
3.1. Basel 2.5
3.2. Basel III
3.3. The Volcker Rule
4. First-order impact on dealer liquidity provision
4.1. The business model of market makers
4.2. Channels of regulatory impact
4.3. Foundations of contemporary literature
4.4. Evidence of the regulatory impact on traditional dealers
5. Changes in market structure and behavior
5.1. Second-order effect (1): Shift from principal trading to matchmaking
5.2. Second-order effect (2): Migration of market making to non-bank dealers
6. Evidence of aggregate corporate bond market liquidity
6.1. Price-based liquidity measures
6.2. Trading-based liquidity measures
6.3. Liquidity under stress
7. Conclusion
References
Appendix
- Citar trabajo
- Michael Kreienbaum (Autor), 2020, Regulation after the Financial Crisis. Impact on Corporate Bond Market Liquidity, Múnich, GRIN Verlag, https://www.grin.com/document/1128191
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