Corporate Bond Liquidity during the COVID-19 Crisis

Abstract

We study liquidity conditions in the corporate bond market during the COVID-19 pandemic. We document that the cost of trading immediately via risky-principal trades dramatically increased at the height of the sell-off, forcing customers to shift toward slower agency trades. Exploiting eligibility requirements, we show that the Federal Reserve’s corporate credit facilities have had a positive effect on market liquidity. A structural estimation reveals that customers’ willingness to pay for immediacy increased by about 200 bps per dollar of transaction, but quickly subsided after the Fed announced its interventions. Dealers’ marginal cost also increased substantially but did not fully subside.

Effects of the Covid‐19 pandemic on derivatives markets: Evidence from global futures and options exchanges

“…Another strand of literature has focused on the effect of Covid‐19 on financial and commodity market liquidity. This study has documented deteriorated liquidity conditions in the US fixed‐income market, including US Government bonds (Ermolov, 2020) and corporate bonds (Kargar et al, 2020; O'Hara & Zhou, 2021). Focusing on agricultural futures markets, Peng et al (2021) find a substantial decrease in soybean futures liquidity several weeks before US equity, bond as well as other agricultural markets were impacted.…”

COVID-19 as a stress test: Assessing the bank regulatory framework

“…The unprecedented trading volumes temporarily overwhelmed BHCs, exceeding their capacity to intermediate the U.S. Treasury market ( Duffie, 2020 , Federal Reserve Board, 2020 , Schrimpf et al, 2020 ). Similarly, amid selling pressures in the corporate bond market in mid-March, BHCs showed signs of reluctance to increase holdings lest they fall below regulatory capital requirements ( Aramonte and Avalos, 2020 , Kargar et al, 2021 , O’Hara and Zhou, 2021 ). In order to ease market pressures, the Federal Reserve launched a large-scale asset purchase program of U.S. Treasury securities and mortgage-backed securities (MBS) on March 15, 2020.…”

“…On April 9, these programs were further expanded to include the purchases of eligible corporate bond portfolios in the form of exchange-traded funds with exposure to U.S. high-yield corporate bonds. Corporate bond market liquidity improved significantly following these interventions ( Boyarchenko et al, 2020 , Haddad et al, 2021 , Kargar et al, 2021 ).…”

“…The unprecedented deposit inflow was a result of multiple factors. It was partly due to the flight to safety by nonfinancial firms and investors, which sold riskier assets and increased bank deposits in response to the economic uncertainty and short-term funding market turmoil caused by the unfolding pandemic ( Duffie, 2020 , He et al, 2022 , Kargar et al, 2021 , Li et al, 2020 ). Furthermore, as we describe in Section 6 , many nonfinancial firms drew down their credit lines in Q1 2020 and increased their bank deposits to prepare for potential liquidity shortages in the future—a link also examined by Glancy et al (2020) .…”

Debt-Maturity Management with Liquidity Costs

“…6 As we noted above, we build on Vayanos and Vila (2021) and Duffie et al (2005) and motivate liquidity costs through a combination of bond-market segmentation and overthe-counter frictions. These frictions have received a lot of recent attention, especially in light of recent disruptions in the US Treasury markets-see for example Duffie (2020) or Kargar, Lester, Lindsay, Liu, Weill and Zúñiga (2020). Relative to this ample literature, to the best of our knowledge, we are the first to study how the frictions introduced in those papers impact the optimal management of public debt.…”