Dealer Liquidity Provision and the Breakdown of the Law of One Price: Evidence from the CDS-Bond Basis

• 成果类型: Article
• 署名作者: Choi, Jaewon; Shachar, Or; Shin, Sean Seunghun
• 署名单位: University of Illinois System; University of Illinois Urbana-Champaign; Federal Reserve System - USA; Federal Reserve Bank - New York; Aalto University
• 刊物名称: MANAGEMENT SCIENCE
• ISSN/ISSBN: 0025-1909
• DOI: 10.1287/mnsc.2017.3011
• 发表日期: 2019
• 页码: 4100-4122
• 关键词: CDS-bond basis; OTC market liquidity; Limits to arbitrage; liquidity provision; Corporate bonds

摘要

We examine dealers' liquidity provision against mispricing in the corporate bond market from 2005 to 2009. Dealers on average serve as stabilizing liquidity providers by trading against widening price gaps between corporate bonds and credit default swaps (the CDS-bond basis). However, dealers cut back on liquidity provision as they suffer losses, mispricing becomes wider, or the funding situation worsens, consistent with the limited capital capacity of financial intermediaries. We also show that the unwinding of basis arbitrage trading can amplify mispricing by documenting that bond returns following the Lehman collapse were very low for bonds with strong preexisting basis arbitrage activity and for bonds underwritten by Lehman Brothers. Liquidity demand due to the exit of arbitrageurs can be a major driver of disruption in credit markets.