Liquidity in debt markets.

Resumen

Liquidity in fixed income markets have aroused investors’ interest especially during episodes of financial distress. This interest arises mainly for the implied safety that fixed income assets traditionally seems to report in contrast to volatility in stock exchange markets during turmoil periods. In this sense, the Bank for International Settlements (BIS) Committee on the Global Financial System highlight the sudden deterioration in liquidity during the global market turmoil on 1997 and 1998, and the need to understand an unexplored topic until then. This doctoral Thesis is focused in liquidity in debt markets. We are interested into study liquidity and its aspects in both fixed income markets, the US Treasury bond and the US corporate bond markets. Whereas traded assets agree on the basics, their particular features, performance, regulation and participants differs substantially among each other, leading to different liquidity states. We analyze liquidity in the US Treasury bond market and its impact in bond’s prices. We use a wide range of liquidity measures that measure different facets of liquidity. Computed as a function of age, it is possible to estimate a liquidity term structure adjusting different age-based functions. This term structure present an aged-based deterministic component as well as a random stochastic component. Liquidity measured throughout market impact measures, present a regular and predictable behavior and a main aged-based component. The liquidity term structure allow us to estimate the expected liquidity level depending on the age of the bond and also the unexpected component of liquidity. Both components, expected and unexpected, as well as current liquidity, explain the liquidity premiums that 2-year US Treasury notes seems to have embedded. Otherwise, liquidity in the US corporate bond market is quite different than in the Treasury market. One of the main reasons is that traded bonds in the secondary over-the-counter market are risky assets in a lesser or greater extent, meanwhile bonds from the Treasury are considered as risk-free assets by investors. Credit risk can be addressed by the Credit Ratings (CRs) provided by Credit Rating Agencies (CRAs). Any change in the creditworthiness of the issuer will involve a change in the credit rating assigned to his issues, and probably will lead to a change in security’s prices and costs and hence in liquidity. We address the impacts of credit rating changes in terms of shocks in liquidity, finding that the greater impacts occur around credit event downgrades. Furthermore, we analyze if liquidity variations before credit event announcements can act as a signal of an imminent credit rating change. Abnormal liquidity levels occur before and after the rating change, and we find evidence that features able to explain these abnormal levels are both rating and agency specific features. Additionally, impacts from credit rating downgrades on liquidity may be conditioned by the investor/bondholder type. We examine if trading activity and liquidity patterns of the two segments operating in the corporate bond market, the institutional and the retail, reacts in a different degree to credit rating downgrades. We find that rating-specific constraints, rating-specific capital requirements, and risk tolerance limits are ahead of the different intensity of trading patterns around credit event downgrades. Besides in a risk-liquidity binomial model we analyze the impact on the probability of occurrence of some specific trading patterns related with the existence of asymmetric information or the existence of informative credit events. References: Bank for International Settlements (1999). A review of financial market events in autumn 1998. CGFS Reports, (12).