Staff Working Paper No. 1,126
By Carole Comerton-Forde, Billy Ford, Thierry Foucault and Simon Jurkatis
Investors act as a liquidity backstop in the corporate bond market. By providing liquidity, investors help ease dealers’ balance sheet constraints, especially during market stress. During the March 2020 Dash-for-Cash, in bonds where investors stopped providing liquidity, transaction costs rose by 38%. We find the composition of types of liquidity providers – rather than just their presence – shapes trading costs. Dealers relying on flexible-mandate investors, such as hedge funds, are more resilient to liquidity shocks. Dealers offer discounts to investors for past liquidity services to maintain liquidity provider networks. These discounts represent two thirds of relationship discounts.
Investors as a liquidity backstop in corporate bond markets 