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Customer Liquidity Provision: Implications for Corporate Bond Transaction Costs

Author

Listed:
  • Jaewon Choi

    (Department of Finance, University of Illinois Urbana-Champaign, Champaign, Illinois 61820; Yonsei Business School, Yonsei University, Seoul, South Korea)

  • Yesol Huh

    (Federal Reserve Board, Washington, District of Columbia 20551)

  • Sean Seunghun Shin

    (Department of Finance, Aalto University School of Business, 02150 Espoo, Finland)

Abstract

The convention when calculating corporate bond trading costs is to estimate bid–ask spreads that customers pay, implicitly assuming that dealers always provide liquidity to customers. We show that, contrary to this assumption, customers increasingly provide liquidity following the adoption of post-2008 banking regulations, and thus, conventional bid–ask spread measures underestimate the cost of dealers’ liquidity provision. Among large trades wherein dealers use inventory capacity, customers pay 40%–60% wider spreads than before the crisis. Customers’ balance-sheet capacity and their trading relationships with dealers are important determinants of customer liquidity provision.

Suggested Citation

  • Jaewon Choi & Yesol Huh & Sean Seunghun Shin, 2024. "Customer Liquidity Provision: Implications for Corporate Bond Transaction Costs," Management Science, INFORMS, vol. 70(1), pages 187-206, January.
    • Handle: RePEc:inm:ormnsc:v:70:y:2024:i:1:p:187-206
    DOI: 10.1287/mnsc.2022.4646
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    References listed on IDEAS

    as
    1. Erik Vogt & Michael Fleming & Or Shachar & Tobias Adrian, 2017. "Market Liquidity After the Financial Crisis," Annual Review of Financial Economics, Annual Reviews, vol. 9(1), pages 43-83, November.
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    5. Bessembinder, Hendrik & Maxwell, William & Venkataraman, Kumar, 2006. "Market transparency, liquidity externalities, and institutional trading costs in corporate bonds," Journal of Financial Economics, Elsevier, vol. 82(2), pages 251-288, November.
    6. Mike Anderson & René M. Stulz, 2017. "Is Post-Crisis Bond Liquidity Lower?," NBER Working Papers 23317, National Bureau of Economic Research, Inc.
    Full references (including those not matched with items on IDEAS)

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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. The Costs of Inefficient Regulation: The Volcker Rule
      by Kim Schoenholtz in Money, Banking and Financial Markets on 2019-09-23 12:54:49

    Citations

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    Cited by:

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    2. Mahyar Kargar & Benjamin Lester & David Lindsay & Shuo Liu & Pierre-Olivier Weill & Diego Zúñiga, 2021. "Corporate Bond Liquidity during the COVID-19 Crisis [The day coronavirus nearly broke the financial markets]," The Review of Financial Studies, Society for Financial Studies, vol. 34(11), pages 5352-5401.
    3. Bicu-Lieb, Andreea & Chen, Louisa & Elliott, David, 2020. "The leverage ratio and liquidity in the gilt and gilt repo markets," Journal of Financial Markets, Elsevier, vol. 48(C).
    4. Gündüz, Yalin & Ottonello, Giorgio & Pelizzon, Loriana & Schneider, Michael & Subrahmanyam, Marti G., 2018. "Lighting up the dark: Liquidity in the German corporate bond market," SAFE Working Paper Series 230, Leibniz Institute for Financial Research SAFE.
    5. Nathan Foley-Fisher & Stefan Gissler & Stephane Verani, 2019. "Over-the-Counter Market Liquidity and Securities Lending," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 33, pages 272-294, July.
    6. Mattia Landoni & Stephen P. Zeldes, 2020. "Should the Government be Paying Investment Fees on $3 Trillion of Tax-Deferred Retirement Assets?," NBER Working Papers 26700, National Bureau of Economic Research, Inc.
    7. Czech, Robert & Pintér, Gábor, 2020. "Informed trading and the dynamics of client-dealer connections in corporate bond markets," Bank of England working papers 895, Bank of England, revised 20 Jan 2022.
    8. Huh, Yesol & Infante, Sebastian, 2021. "Bond market intermediation and the Role of Repo," Journal of Banking & Finance, Elsevier, vol. 122(C).
    9. Baranova, Yuliya & Douglas, Graeme & Silvestri, Laura, 2019. "Simulating stress in the UK corporate bond market: investor behaviour and asset fire-sales," Bank of England working papers 803, Bank of England.
    10. Söhnke M. Bartram & Mark Grinblatt & Yoshio Nozawa, 2020. "Book-to-Market, Mispricing, and the Cross-Section of Corporate Bond Returns," NBER Working Papers 27655, National Bureau of Economic Research, Inc.
    11. Jonathan Goldberg & Yoshio Nozawa, 2021. "Liquidity Supply in the Corporate Bond Market," Journal of Finance, American Finance Association, vol. 76(2), pages 755-796, April.
    12. Goldstein, Michael A. & Hotchkiss, Edith S., 2020. "Providing liquidity in an illiquid market: Dealer behavior in US corporate bonds," Journal of Financial Economics, Elsevier, vol. 135(1), pages 16-40.
    13. Antonio Falato & Diana A. Iercosan & Filip Zikes, 2019. "Banks as Regulated Traders," Finance and Economics Discussion Series 2019-005r1, Board of Governors of the Federal Reserve System (U.S.), revised 04 Aug 2021.
    14. Corey Garriott & Jesse Johal, 2018. "Customer Liquidity Provision in Canadian Bond Markets," Staff Analytical Notes 2018-12, Bank of Canada.
    15. Mallaburn, David & Roberts-Sklar, Matt & Silvestri, Laura, 2019. "Resilience of trading networks: evidence from the sterling corporate bond market," Bank of England working papers 813, Bank of England.

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    More about this item

    Keywords

    corporate bond liquidity; customer liquidity provision; bank regulations and OTC liquidity; insurer liquidity provision;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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