Tag Archives: Funding liquidity

Does market liquidity risk affect Euro corporate bond returns more seriously in stress periods?

Wolfgang Aussenegg, Louisa Chen, Ranko Jelic and Dietmar Maringer.

Investors require compensation for holding risky assets – an example is the bond liquidity premium for holding debt assets. In stress conditions, market liquidity can evaporate and lead to disorderly movements in prices. The Bank of England’s recent Financial Stability Report (p.29) documents a decline in the market liquidity of some government and corporate bonds, accompanied by a reduction in dealer activity. Does market liquidity risk affect bond returns more seriously in stress times than in normal times? Does a higher cost of funding for dealers in stress times cause bond returns to be more sensitive to liquidity shocks? Focusing on Euro-dominated investment-grade corporate bonds, we conduct a quantitative analysis in a regime-switching model, and confirm a ‘yes’ answer to both of these questions.

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