Liquidity, Volatility, and Flights to Safety in the U.S. Treasury Market: Evidence from a New Class of Dynamic Order Book Models

Engle, Robert F.; Fleming, Michael J.; Ghysels, Éric; Nguyen, Giang

doi:10.2139/ssrn.2195655

Cited by 41 publications

(26 citation statements)

References 63 publications

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“…Fleming and Mizrach (2009) provide a detailed description of this market and an analysis of its liquidity, showing the latter to be much greater than has been reported in prior studies using less detailed data from GovPX. Using more recent data from BrokerTec, Engle, Fleming, Ghysels and Nguyen (2011) propose a new class of dynamic order book models based on prior work by Engle (2002). They show that liquidity decreases with price volatility, but increases with liquidity volatility.…”

Section: Literature Surveymentioning

confidence: 99%

Sovereign Credit Risk, Liquidity, and ECB Intervention: Deus Ex Machina?

Pelizzon

Subrahmanyam

Tomio³

et al. 2015

SSRN Journal

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This paper explores the interaction between credit risk and liquidity, in the context of the intervention by the European Central Bank (ECB), during the Euro-zone crisis. The laboratory for our investigation is the Italian sovereign bond market, the largest in the Euro-zone. We use a unique data set obtained from the Mercato dei Titoli di Stato (MTS), which provides tick-by-tick trade and quote data from individual broker-dealers. Our database covers the sovereign bonds of most European-zone countries, for the period June 1, 2011 to December 31, 2012, which includes much of the Euro-zone crisis period.We document a strong and dynamic relationship between changes in Italian sovereign credit risk and liquidity in the secondary bond market, conditional on the level of credit risk, measured by the Italian sovereign credit default swap (CDS) spread. We demonstrate the existence of a threshold of 500 basis points (bp) in the CDS spread, above which there is a structural change in this relationship. Other global systemic factors also affect market liquidity, but the specific credit risk of primary dealers plays only a modest role in affecting market liquidity, especially under conditions of stress.Moreover, the data indicate that there is a clear structural break following the announcement of the implementation of the Long-Term Refinancing Operations (LTRO) by the European Central Bank (ECB) on December 8, 2012. The improvement in liquidity in the Italian government bond market strongly attenuated the dynamic relationship between credit risk and market liquidity. The only variable that continues to have an impact on market liquidity is the global funding liquidity variable: the Euro-US Dollar cross-currency basis swap, a measure of Eurozone-wide macro-liquidity. Thus, the ECB intervention was successful in ameliorating both credit risk and illiquidity.Keywords: Liquidity, government bonds, financial crisis, MTS bond market JEL Classification: G01, G12, G14. * Ca' Foscari University of Venice and Goethe University Frankfurt, Stern School of Business at New York University, Copenhagen Business School, and Waseda University, respectively. We thank Einaudi Institute of Economics and Finance, the NYU Stern Center for Global Economy and Business, and the NYU-Salomon Center for financial Support. We thank Monica Billio, Rohit Deo, Rama Cont, Clara Vega and participants at the CREDIT 2013 Conference, Venice, for their insightful comments on a previous draft of this paper. We thank Stefano Bellani, Mitja Blazincic, Alberto Campari, Alfonso Dufour, Carlo Draghi, Peter Eggleston, Sven Gerhardt, and Davide Menini for sharing their thorough understanding of market practice with us. We also thank the MTS group for providing us with access to their tick-by-tick trade and quote database and, in particular, Simon Linwood and Christine Sheeka, for their assistance in interpreting the data. The views expressed in the paper are those of the authors and are not necessarily reflective of the views of the MTS group. We are responsibl...

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Section: Literature Surveymentioning

confidence: 99%

Sovereign Credit Risk, Liquidity, and ECB Intervention: Deus Ex Machina?

Pelizzon

Subrahmanyam

Tomio³

et al. 2015

SSRN Journal

View full text Add to dashboard Cite

show abstract

“…They also analyze the price impact of trades and the effect of "iceberg" orders, which are partly hidden from the market. Engle, Fleming, Ghysels and Nguyen (2011) propose a new class of dynamic order book models based on prior work by Engle (2002). They study the interaction between liquidity and volatility and show that liquidity decreases with price volatility, but increases with liquidity volatility.…”

Section: Literature Surveymentioning

confidence: 99%

The Microstructure of the European Sovereign Bond Market: A Study of the Euro-Zone Crisis

Pelizzon

Martí²,

Tomio³

et al. 2013

SSRN Journal

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We study market microstructure and liquidity in the Italian sovereign bond market, the largest in the Euro-zone, using a unique new dataset, recently obtained from the Mercato Telematico dei Titoli di Stato (MTS), which provides tick-by-tick trade and quote data from individual broker-dealers. Our data cover the sovereign bonds of most European Union countries, for the period June 1, 2011 to November 15, 2012, which includes the Euro-zone crisis period. This database is unique for any market, in that it allows us to track individual orders and their revisions during the trading day. We document the strong non-linear relationship between changes in Italian sovereign risk and liquidity in the secondary bond market. We pinpoint which subset of bonds was the least affected by the worsening of the crisis, in terms of liquidity, and to what extent it was resilient to the deterioration of Italy's creditworthiness. We document that, under conditions of stress, a fraction of market makers withdraws from the market and frequent quote revisions do not necessarily translate into higher liquidity. We also examine how liquidity improved after intervention by the European Central Bank (ECB), through its Long-Term Refinancing Operations (LTRO) and Outright Monetary Transactions (OMT) programs, starting in December 2011. Thus, we are able to assess the efficacy of the intervention by studying the changing interaction between the liquidity measures and credit default swap (CDS) spreads, to examine whether the intervention was successful in ameliorating credit risk and illiquidity.

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“…Dealers arise naturally in these markets because of their ability to bypass the frictions that make direct trade among investors difficult. The bid-ask spread for U.S. bonds ranges from roughly 0.8 basis points for 2-year notes to 1.5 basis points for 10-year bonds (Engle et al 2012); these are small compared to other markets, but when multiplied by the enormous volume of trade (in the range of hundreds of billions per day), they represent significant absolute trading costs. Even for the next most liquid asset class-high-quality corporate bond-bid-ask spreads are much larger: on the order of 8 basis points in 2007 and almost twice as high in recent years.…”

Section: Discussion Of the Physical Environmentmentioning

confidence: 99%

A search-theoretic model of the term premium

Geromichalos

Herrenbrueck

Salyer

2016

Theoretical Economics

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A consistent empirical feature of bond yields is that term premia are, on average, positive. The majority of theoretical explanations for this observation have viewed the term premia through the lens of the consumption based capital asset pricing model. In contrast, we harken to an older empirical literature that attributes the term premium to the idea that short maturity bonds are inherently more liquid. The goal of this paper is to provide a theoretical justification of this concept. To that end, we employ a monetary‐search model extended to include assets of different maturities. Short term assets mature in time to take advantage of random consumption opportunities. Long term assets cannot be used directly to purchase consumption, but agents may liquidate them in a secondary asset market characterized by search and bargaining frictions. Our model delivers three results that are consistent with empirical facts. First, long term assets have higher rates of return in steady state to compensate agents for their relative lack of liquidity. Second, since the difference in the yield of short and long term assets reflects asset market frictions, our model predicts a steeper yield curve for assets that trade in less liquid secondary markets. Third, our model predicts that freshly issued (“on‐the‐run”) assets will sell at higher prices than previously issued (“off‐the‐run”) assets that mature in nearby dates, because sellers of the latter have a more urgent need for liquidity.

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Liquidity, Volatility, and Flights to Safety in the U.S. Treasury Market: Evidence from a New Class of Dynamic Order Book Models

Cited by 41 publications

References 63 publications

Sovereign Credit Risk, Liquidity, and ECB Intervention: Deus Ex Machina?

Sovereign Credit Risk, Liquidity, and ECB Intervention: Deus Ex Machina?

The Microstructure of the European Sovereign Bond Market: A Study of the Euro-Zone Crisis

A search-theoretic model of the term premium

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