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Notes on Bonds: Illiquidity Feedback During the Financial Crisis

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  • David Musto
  • Greg Nini
  • Krista Schwarz

Abstract

We trace the evolution of extreme illiquidity discounts among Treasury securities during the financial crisis, when bond prices fell more than 6% below more liquid but otherwise identical notes. Using high-resolution data on market quality and trader identities and characteristics, we find that the discounts amplify through feedback loops, where cheaper, less-liquid securities flow to longer-horizon investors, thereby increasing their illiquidity and thus their appeal to these investors. The effect of the widened liquidity gap on transactions costs is further amplified by a surge in the price liquidity providers charge for access to their balance sheets in the crisis. Received September 28, 2016; editorial decision January 2, 2018 by Editor Philip Strahan. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

Suggested Citation

  • David Musto & Greg Nini & Krista Schwarz, 2018. "Notes on Bonds: Illiquidity Feedback During the Financial Crisis," The Review of Financial Studies, Society for Financial Studies, vol. 31(8), pages 2983-3018.
    • Handle: RePEc:oup:rfinst:v:31:y:2018:i:8:p:2983-3018.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhy022
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    7. Adam Copeland & Antoine Martin, 2021. "Repo over the Financial Crisis," Staff Reports 996, Federal Reserve Bank of New York.
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