The Determinants of Liquidity in the Corporate Bond Markets: An Application of Latent Liquidity

Chacko, George; Mahanti, Sriketan; Malik, Gaurav; Subrahmanyam, Marti G.

doi:10.2139/ssrn.687134

Cited by 11 publications

(5 citation statements)

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“…19 Chacko et al (2005) study the determinants of liquidity in the US corporate bond market using a dataset of whenissued and secondary market trades. Nyborg and Sundaresan (1996), among others, study when-issued trading in the US Treasury market.…”

Section: How Does the Supply Of Cbs Affect Convertible Arbitrageurs?mentioning

confidence: 99%

“…Therefore, the first step to constructing an accurate proxy of CB supply is to gauge how far in time CB deals are announced in advance of eventual issuance. To that end, we randomly sample (without replacement) 100 CBs that are issued during our sample period and manually collect the earliest announcement date from Factiva news search supplemented with19 Chacko et al (2005) study the determinants of liquidity in the US corporate bond market using a dataset of whenissued and secondary market trades. Nyborg and Sundaresan (1996), among others, study when-issued trading in the US Treasury market.…”

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Risk and return in convertible arbitrage: Evidence from the convertible bond market

Agarwal

Fung

Loon

et al. 2011

Journal of Empirical Finance

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In this paper, we identify and document the empirical characteristics of the key drivers of convertible arbitrage as a strategy and how they impact the performance of convertible arbitrage hedge funds. We show that the returns of a buy-and-hedge strategy involving taking a long position in convertible bonds ("CBs") while hedging the equity risk alone explains a substantial amount of these funds' return dynamics. In addition, we highlight the importance of non-price variables such as extreme market-wide events and the supply of CBs on performance. Out-ofsample tests provide corroborative evidence on our model's predictions. At a more micro level, larger funds appear to be less dependent on directional exposure to CBs and more active in shorting stocks to hedge their exposure than smaller funds. They are also more vulnerable to supply shocks in the CB market. These findings are consistent with economies of scale that large funds enjoy in accessing the stock loan market. However, the friction involved in adjusting the stock of risk capital managed by a large fund can negatively impact performance when the supply of CBs declines. Taken together, our findings are consistent with convertible arbitrageurs collectively being rewarded for playing an intermediation role of funding CB issuers whilst distributing part of the equity risk of CBs to the equity market.Keywords: Hedge funds, Convertible Bonds, Convertible arbitrage, Supply, Risk Factors JEL classification: G10, G19, G23 1 IntroductionAt the turn of the century, capitalization of the global convertible bond ("CB") market stood at just under $300 billion while the US equity market was more than 50 times higher at over $1.5 trillion. Yet during the difficult market conditions between 2000 and 2002 (with events such as end to the dotcom bubble, September 11, and the accounting scandals at Worldcom and Enron), the new issues in both these markets were of similar orders of magnitude-close to $300 billion. Even during the financial crisis of [2007][2008], firms managed to raise about $118 billion in the US CB market. 1 This underscores the importance of the CB market as a source of capital for corporations during adverse economic conditions. 2To smooth the placement of such a large-scale issuance of CBs, economic agents willing to assume the inventory risk are clearly needed. Coincident to these macro events, the last decade has witnessed a rapid growth of convertible arbitrage ("CA 1 Equity data are from Federal Reserve Bulletin (various issues). We thank Jeff Wurgler for making it available on his website http://pages.stern.nyu.edu/~jwurgler/. CB estimate is from the public and private proceeds of convertible debt from Thomson Reuters Financial's SDC Platinum database, which we also use later on for our out-of-sample analysis. 2 Apart from being a useful source of liquidity to issuers during adverse market conditions, the issuance of CBs depends also on the costs and benefits compared to other forms of securities issuance. Firms selling CBs incur costs inclu...

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Section: How Does the Supply Of Cbs Affect Convertible Arbitrageurs?mentioning

confidence: 99%

mentioning

confidence: 99%

Risk and return in convertible arbitrage: Evidence from the convertible bond market

Agarwal

Fung

Loon

et al. 2011

Journal of Empirical Finance

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“…(2) the direction (counterparty buys or sells); (3) the quantity; (4) the transaction price; (5) the type of counterparty  deal-1 Intraday trading in the major currency pairs is never constrained by supply because banks create deposits. During our sample period foreign exchange dealers were effectively the only intraday suppliers of liquidity so there is no need to consider "latent liquidity" (Chacko et al (2006)).…”

Section: Foreign Exchange Market Structure and Datamentioning

confidence: 99%

Price Discovery in Currency Markets

2007

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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 EconStor may AbstractThis paper makes three contributions to our understanding of the price discovery process in currency markets. First, it provides evidence that this process cannot be the familiar one based on adverse selection and customer spreads, since such spreads are inversely related to a trade's likely information content. Second, the paper suggests three potential sources for the pattern of customer spreads, two of which rely on the information structure of the market. Third, the paper suggests an alternative price discovery process for currencies, centered on inventory management strategies in the interdealer market, and provides preliminary evidence for that process. PRICE DISCOVERY IN CURRENCY MARKETSThis paper investigates the price discovery process in the foreign exchange market. Understanding exactly how information becomes embedded in exchange rates is central to current efforts to understand exchange-rate dynamics (see, for example, Evans and Lyons (2002), (2004)). Within microstructure per se there is also a powerful incentive to study foreign exchange trading, since the currency market dwarfs all others. Nonetheless, the overall contours of price discovery in foreign exchange remain murky.Our paper makes three contributions, all of which build on the observation that the foreign exchange market has two tiers, similar to the London Stock Exchange and some bond markets. In one, dealers trade with each other; in the other, dealers trade with (non-dealer) customers. The paper first provides evidence that spreads in the customer market are inversely related to a trade's likely information content, which implies that price discovery in FX cannot be determined by adverse selection. Second, the paper suggests three potential sources for this pattern of customer spreads, two of which are based on the information structure of the market. Finally, the paper proposes a price discovery process centered on dealers' inventory management strategies in the interbank market and provides evidence for that process. Since this process reflects the foreign exchange market's two-tiered structure it has the potential to be relevant in liquid two-tiered markets for other assets.The adverse-selection-based price discovery process, articulated in Glosten and Milgrom (1985) and Easley and O'Hara (1987), among other important works, asserts that dealers build into their price quotes the potential information revealed by a given cu...

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“…Chen, Lesmond and Wei (2004) show that credit spreads are correlated with an estimate of the effective bid-ask spread. Finally, Chacko, Mahanti, Mallik, and Subrahmanyam (2005) and Nashikkar and Subrahmanyam (2006) construct a new measure for corporate bond liquidity, based on the trading activity of investors holding the bond, and show that this measure is related to the non-default component of credit spread levels. However, none of these studies investigates the time-variation in liquidity and the pricing of liquidity risk for corporate bonds, which constitutes the main contribution of this paper.…”

Section: Related Literaturementioning

confidence: 99%