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 increased dramatically at the height of the sell-off, forcing customers to shift towards slower, agency trades. Exploiting eligibility requirements, we show that the Federal Reserve's corporate credit facilities 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.

When Selling Becomes Viral: Disruptions in Debt Markets in the COVID-19 Crisis and the Fed’s Response

“…This is the flip side of our previous point: the large price response despite a wide gap between announcement and implementation suggests that immediate balance-sheet constraints are not the only issue. Further consistent with the idea that dislocations did not close because of improved short-term liquidity, Kargar et al (2020) find little immediate impact of the announcements on trading costs overall and no differential effects for high-yield relative to investment-grade bonds.…”

“…These observations alleviate measurement concerns one might have about the basis. However, they do not imply an absence of trading frictions—for example, Kargar et al (2020) document increases in trading costs—or that these frictions are not important to understand overall price movements. Our observation that volume does not dry up also follows from our initial example of Google in Figure 1 .…”

“…In addition, corporate bond trades might have been crowded out by better opportunities in the also disrupted Treasury market (see Duffie 2020 and He, Nagel, and Song 2020 ). One manifestation of this lower willingness to intermediate is that the price that dealers charge for trading bonds rose during this period ( Kargar et al (2020) ). However, our findings suggest these explanations are not enough and other forces pushed dealers away.…”

“…Several papers focus specifically on liquidity in bond markets in the COVID-19 crisis as well, including O’Hara and Zhou (2020) , Kargar et al (2020) , Fleming and Ruela (2020) , Schrimpf, Shin, and Sushko (2020) , and Boyarchenko, Kovner, and Shachar (2020) . Falato, Goldstein, and Hortaçsu (2020) and Ma, Xiao, and Zeng (2020) focus instead on the sources and implications of large redemption by bond mutual funds.…”

A Tale of Two Crises: The 2008 Mortgage Meltdown and the 2020 COVID-19 Crisis

“…A natural context to understand the nature of bond liquidity is to use exchange-traded fund data around Federal Reserve interventions, building on the interesting analysis in Haddad, Moreira, and Muir (2020) , who show that prior to the Fed intervention ETFs traded at a discount (especially for safer bonds). 24 Major steps by the Federal Reserve on March 23 rd addressed liquidity dislocations (see discussion in Haddad, Moreira, and Muir [2020] , who document dramatic adjustment in the pricing of investment-grade cash bonds versus credit-default swaps after severe market dislocations, as well as reductions in bond trading costs then as highlighted in Kargar et al. 2020 ).…”