Episodes of vanishing market liquidity haunt dealers. This was true in the great stock market crash of 1929 and remains so today: in August 2018, professional corporate bond traders cited vanishing liquidity as their primary source of worry. Dealers in more-liquid long gilt futures – contracts on 10 year UK government bonds – might be less concerned. But have structural changes in the market led to less resilience over time? We address this question in a recent Staff Working Paper. We find that liquidity in the long gilt futures market has increased slightly over recent years, while remaining resilient to periods of market stress.
The yield curve is an important barometer of market sentiment and reflects interest rate expectations as well as different risk premia. In this post, we show how changes in demand for UK government bonds, also called gilts, may affect the shape of the yield curve. We find that demand shocks have persistent local effects on the yield curve, in particular at longer maturities and during volatile market conditions. These findings therefore indicate that investors in longer-term gilts tend to be less price-sensitive. Moreover, we find that demand shocks for one bond transmit to neighbouring bonds, while the transmission to other bonds declines with the difference in the residual maturity.
Carlo Favero, Sebastian Vismara and Iryna Kaminska
The slope of the yield curve has decreased in the US and the UK over the last few years (Chart 1). This development is attracting significant attention, because the yield curve slope (i.e. the difference between longer term government bond yields and shorter term government bond yields) is a popular business cycle indicator, and a fall of longer term yields below shorter term yields (i.e. an ‘inversion’ of the yield curve) has historically been considered as a powerful signal of recessions, particularly in the US.
Post-crisis regulatory reforms have reshaped and increased the amount of clearing activity in the OTC derivatives market. An emerging issue is so-called “client porting” – i.e. how central counterparties (CCPs) can transfer positions from one clearing member (CM) to another in the aftermath of one member defaulting. In this post, we discuss possible ways to offer clients temporary access to clearing services following a CM default, which we believe could increase the likelihood of successfully porting clients and avoiding further pressure on prices and market stability.
Over the past 20 years, the share of outstanding corporate bonds rated BBB, the lowest investment-grade rating, has more than doubled. This has left a large volume of securities on the edge of a cliff, from which they could drop to a high-yield rating and become so-called ‘fallen angels’. Some investors may be forced to sell ‘fallen angels’, for example if their mandate prevents them from holding high-yield bonds. And this selling pressure could push bond prices down, beyond levels consistent with the downgrade news. In this post we explore the impact that sales of ‘fallen angels’ could have on market functioning, finding that they could test the liquidity of the sterling high-yield corporate bond market.
Gino Cenedese, Pasquale Della Corte and Tianyu Wang
Deviations from covered interest parity (CIP) represent an arbitrage opportunity, at least in theory. In a new paper, we show that post-crisis financial regulation may explain why this mispricing persists and cannot be arbitraged away. Our exercise uses a unique dataset on contract-level foreign exchange derivatives coupled with an exogenous variation associated with the public disclosure of the leverage ratio. We find that dealers with a higher leverage ratio demand an extra premium from their clients for synthetic dollar funding (e.g., borrowing in euros and swapping into dollars) relative to direct dollar funding (i.e., borrowing dollars in the money market), resulting in CIP deviations.
How do banks adjust when faced with a sudden rise in capital requirements? The most frequent response, in the theoretical literature, is that they reduce lending or “deleverage” (see, e.g., Aiyagari and Gertler (1999); Gertler and Kiyotaki (2010). This is particularly true in crisis episodes when raising equity can be costly. However, in a new paper co-authored with Hans Degryse and Artashes Karapetyan, I show this is only part of the story. Banks may also ask borrowers to provide more collateral; collateralised exposures carry lower risk weights on average and hence enhance capital ratios. This requirement can adversely affect young and new borrowers that typically lack collateral to pledge and are also unlikely to have longstanding banking relationships.
To consider Bitcoin volatility, we
look at 10-day returns (capital standards typically estimate market risk over a
10-day period) since 19 July 2010, when Bloomberg’s Bitcoin data start. We
compare Bitcoin with assets in three categories – currency pairs, commodities
and equities – and for each we have picked one low-volatility asset and one
more volatile asset. For currency pairs and commodities, we chose the most and
least volatile ones (in terms of standard deviation of 10-day returns) out of
the most liquid in each category. And we chose the most and least volatile FTSE
100 equities (again, in terms of standard deviation of 10-day returns).
For stable assets we expect a peaked distribution with short tails, as returns cluster near 0%. Figure 1 shows that Bitcoin has been more volatile than any other asset in our sample.
But people are often interested in the downside risk of assets. We therefore consider how Bitcoin’s Value at Risk (VaR) compares to other assets. VaR is the maximum loss over a given time interval under normal market conditions at a given confidence interval (eg 99%). A 10-day 99% VaR of -10% tells you that 99% of the time your 10-day return on the asset would be no worse than a 10% loss.
Figure 2 shows Bitcoin’s VaR is high, but the VaR of the other most liquid crypto-assets is higher. TRON’s VaR to date (-84%) is almost twice Bitcoin’s (-44%).
Giulio Malberti and Thom Adcock work in the Bank’s Banking Policy Division.
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