1 Department of Finance, Copenhagen Business School2 Bank for International Settlements (BIS)
Evidence from Danish Bond Markets
This paper shows empirically that funding liquidity drives market liquidity. As it becomes harder to secure term funding in the money markets, liquidity deteriorates in the Danish bond market. We show that the first principal component of bond market liquidity is driven by the market makers' ability to obtain funding. This effect holds true across both long and short term, government and covered bonds. We use MiFID data which provides a complete transaction level dataset for the Danish market covering both the subprime crisis and the Euro sovereign crisis. Furthermore, we verify the findings for other European government bonds using MTS data. The findings suggest that regulatory bond based liquidity buffers for banks will have limited effectiveness.
Market liquidity; Funding liquidity; Government bonds; Covered bonds; Money markets