This paper examines market liquidity in the post-crisis era in light of concerns that regulatory changes might have reduced dealers' ability and willingness to make markets. We begin with a discussion of the broader trading environment, including an overview of regulations and their potential effects on dealer balance sheets and market making, but also considering additional drivers of market liquidity. We document a stagnation of dealer balance sheets after the financial crisis of 2007-09, which occurred concurrently with dealer balance sheet deleveraging. However, using high-frequency trade and quote data for U.S. Treasury securities and corporate bonds, we find only limited evidence of a deterioration in market liquidity.

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in AbstractWe document a highly significant, strongly nonlinear dependence of stock and bond returns on past equity-market volatility as measured by the VIX. We propose a new estimator for the shape of the nonlinear forecasting relationship that exploits additional variation in the cross section of returns. The nonlinearities are mirror images for stocks and bonds, revealing flight to safety: Expected returns increase for stocks when volatility increases from moderate to high levels, while they decline for Treasuries. We further demonstrate that these findings are evidence of dynamic asset pricing theories where the time variation of the price of risk is a function of the level of the VIX.

We document a highly significant, strongly nonlinear dependence of stock and bond returns on past equity market volatility as measured by the VIX. We propose a new estimator for the shape of the nonlinear forecasting relationship that exploits variation in the cross‐section of returns. The nonlinearities are mirror images for stocks and bonds, revealing flight‐to‐safety: expected returns increase for stocks when volatility increases from moderate to high levels while they decline for Treasuries. These findings provide support for dynamic asset pricing theories in which the price of risk is a nonlinear function of market volatility.

The share of market making conducted by high-frequency trading (HFT) firms has been rising steadily. A distinguishing feature of HFTs is that they trade intraday, ending the day flat. To shed light on the economics of HFTs, and in a departure from existing market-making theories, we model an HFT that has access to unlimited leverage intraday but must fund any end-of-day inventory at an exogenously determined cost. Even though the inventory costs occur only at the end of the day, they impact intraday price and liquidity dynamics. This gives rise to an intraday endogenous price impact mechanism. As the end of the trading day approaches, the sensitivity of prices to inventory levels intensifies, making price impact stronger and widening bid-ask spreads. Moreover, imbalances of buy and sell orders may catalyze hikes and drops in prices, even under fixed supply and demand functions. Empirically, we show that these predictions are borne out in the U.S. Treasury market, where bid-ask spreads and price impact tend to rise toward the end of the day. Furthermore, price movements are negatively correlated with changes in inventory levels as measured by the cumulative net trading volume.

We estimate a highly significant price of risk that forecasts global stock and bond returns as a nonlinear function of the CBOE Volatility Index (VIX). We show that countries' exposure to the global price of risk is related to macroeconomic risks as measured by output, credit, and inflation volatility, the magnitude of financial crises, and stock and bond market downside risk. Higher exposure to the global price of risk corresponds to both higher output volatility and higher output growth. We document that the transmission of the global price of risk to macroeconomic outcomes is mitigated by the magnitude of stabilization in the Taylor rule, the degree of countercyclicality of fiscal policy, and countries' tendencies to employ prudential regulations. The estimated magnitudes are quantitatively important and significant, with large cross-sectional explanatory power. Our findings suggest that macroeconomic and financial stability policies should be considered jointly.

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in AbstractThe share of market making conducted by high-frequency trading (HFT) firms has been rising steadily. A distinguishing feature of HFTs is that they trade intraday, ending the day flat. To shed light on the economics of HFTs, and in a departure from existing market-making theories, we model an HFT that has access to unlimited leverage intraday but must fund any end-of-day inventory at an exogenously determined cost. Even though the inventory costs occur only at the end of the day, they impact intraday price and liquidity dynamics. This gives rise to an intraday endogenous price impact mechanism. As the end of the trading day approaches, the sensitivity of prices to inventory levels intensifies, making price impact stronger and widening bid-ask spreads. Moreover, imbalances of buy and sell orders may catalyze hikes and drops in prices, even under fixed supply and demand functions. Empirically, we show that these predictions are borne out in the U.S. Treasury market, where bid-ask spreads and price impact tend to rise toward the end of the day. Furthermore, price movements are negatively correlated with changes in inventory levels as measured by the cumulative net trading volume.

This paper proposes a nonparametric sieve regression framework for pricing the term structure of option spanning portfolios. The framework delivers closed-form, nonparametric option pricing and hedging formulas through basis function expansions that grow with the sample size. Novel confidence intervals quantify term structure estimation uncertainty. The framework is applied to estimating the term structure of variance risk premia and finds that a short-run component dominates market excess return predictability. This finding is inconsistent with existing asset pricing models that seek to explain the variance risk premium's predictive content.

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