Econometrics and Finance Seminar: Sophie Moinas

Funding Constrainsts and Market Liquidity in the European Treasury Bond Market

Sophie MOINAS, Toulouse School of Economics

(Joint with Minh Nguyen and Giorgio Valente)

Theoretical studies show that shocks to funding constraints should affect and be affected by market liquidity. However, little is known about the empirical magnitude of such responses because of the intrinsic endogeneity of liquidity shocks. This paper adopts an identification technique based on the heteroskedasticity of liquidity proxies to infer the reaction of one measure to shocks affecting the other. Using data for the European Treasury bond market, we find evidence that funding liquidity shocks affect bond market liquidity and of a weaker simultaneous feedback effect of market liquidity on funding liquidity. We also investigate the determinants of the magnitude of these effects in the cross-section of bonds characterized by different margin requirements and default risk. We find that the market-to-funding liquidity effect is stronger for bonds with lower haircuts which are used as collaterals in repo transactions.