TY - JOUR
T1 - Sovereign credit risk, liquidity, and European Central Bank intervention
T2 - Deus ex machina?
AU - Pelizzon, Loriana
AU - Subrahmanyam, Marti G.
AU - Tomio, Davide
AU - Uno, Jun
N1 - Funding Information:
We thank the Einaudi Institute of Economics and Finance; the New York University (NYU) Stern Center for Global Economy and Business; the NYU–Salomon Center; the project SYRTO (Systemic Risk Tomography: Signals, Measurements, Transmission Channels, and Policy Interventions) of the European Union under the Seventh Framework Programme (FP7-SSH/2007-2013—grant agreement 320270 ); the project MISURA, funded by the Italian MIUR (Ministry of Education Universities and Research); the Waseda University Center for Finance Research; the Center for Financial Frictions (FRIC) under grant no. DNRF102 from the Danish National Research Foundation ; and SAFE (Sustainable Architecture for Finance in Europe), funded by the State of Hessen initiative for research, LOEWE (State Initiative for the Development of Scientific and Economic Excellence), for their financial support. Part of the research for this paper was conducted while Davide Tomio was employed by SAFE, whose support is gratefully acknowledged. We thank Antje Berndt, Monica Billio, Rohit Deo, Rama Cont, Peter Feldhütter, Eric Ghysels, Bernd Schwaab, Kenneth Singleton, Clara Vega, and participants at the CREDIT 2013 Conference (Venice, Italy), the American Finance Association 2014 meetings (Philadelphia, PA), the NYU-Stern Volatility 2014 Conference, the Financial Management Association 2014 conference (Tokyo, Japan), the second Conference on Global Financial Stability and Prosperity (Sydney, Australia), the European Finance Association 2014 conference, the First International Conference on Sovereign Bond Markets, the Multinational Finance Society Conference, and seminars at the Federal Reserve Bank of New York, the Board of Governors of the Federal Reserve System, the European Central Bank, the Bank of England, the Bank of Italy, the Italian Tesoro (Department of Treasury), Goethe University, University of Mannheim, Frankfurt School of Economics and Finance, Einaudi Institute of Economics and Finance, and the Vienna University of Economics and Business Administration, for their insightful comments. 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 Mercato dei Titoli di Stato (MTS) group for providing us with access to their data sets. The views expressed in the paper are solely ours. We are responsible for all remaining errors. The Internet Appendix can be found online on the Social Science Research Network (SSRN) and at https://www.dropbox.com/s/o8lvp2yj82lrstp/INTERNETAPPENDIX.pdf?dl=0 .
Publisher Copyright:
© 2016
PY - 2016/10/1
Y1 - 2016/10/1
N2 - We examine the dynamic relation between credit risk and liquidity in the Italian sovereign bond market during the eurozone crisis and the subsequent European Central Bank (ECB) interventions. Credit risk drives the liquidity of the market. A 10% change in the credit default swap (CDS) spread leads to a 13% change in the bid-ask spread, the relation being stronger when the CDS spread exceeds 500 basis points. The Long-Term Refinancing Operations of the ECB weakened the sensitivity of market makers’ liquidity provision to credit risk, highlighting the importance of funding liquidity measures as determinants of market liquidity.
AB - We examine the dynamic relation between credit risk and liquidity in the Italian sovereign bond market during the eurozone crisis and the subsequent European Central Bank (ECB) interventions. Credit risk drives the liquidity of the market. A 10% change in the credit default swap (CDS) spread leads to a 13% change in the bid-ask spread, the relation being stronger when the CDS spread exceeds 500 basis points. The Long-Term Refinancing Operations of the ECB weakened the sensitivity of market makers’ liquidity provision to credit risk, highlighting the importance of funding liquidity measures as determinants of market liquidity.
KW - Credit risk
KW - Eurozone sovereign bonds
KW - Financial crisis
KW - Liquidity
KW - MTS bond market
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U2 - 10.1016/j.jfineco.2016.06.001
DO - 10.1016/j.jfineco.2016.06.001
M3 - Article
AN - SCOPUS:84989913222
SN - 0304-405X
VL - 122
SP - 86
EP - 115
JO - Journal of Financial Economics
JF - Journal of Financial Economics
IS - 1
ER -