Thursday 30 April 2020

Nostalgic research: Liquidity in 2007

In 2007, the global markets were about to embark on the last financial crisis. What are the parallels we can draw from past research?

Inquire Europe commemorates their 30th anniversary in 2020. As the planning now stands, the celebration will  culminate with the fall seminar 4 – 6 October in Valencia, Spain. The theme, “Challenges for long term asset allocation over the next 30 years”, has encouraged us to revisit some pieces of research which have been published since Inquire Europe’s establishment.

The first piece of research we have chosen from the archive was published in August 2007, on the precipice of the Great Financial Crisis. Given that we are currently embroiled in a new crisis, we thought it would be a timely reflection. Liquidity, Competition & Price Discovery in the European Corporate Bond Market by Bruno Biais and Fany Declerck, of the Toulouse School of Economics was written at an auspicious time considering the events that would unfold in the markets. The authors could not know that central banks would enter into a long period of quantitative easing and elongated low interest rates. 13 years later, this begs the question: what are the parallels that we identify in the current market? 

Biais and Declerck: “Bonds play a very important role in the financing of our economies. In the US the capitalization of the bond market is roughly the same as that of the stock market. In Europe the former is larger than the latter. Hence, the liquidity of the bond market and its informational efficiency are key determinants of the financing of governments and firms.

Several empirical studies offer interesting evidence about the government bond market. It differs markedly from the corporate bond market, however. The Treasury market involves one powerful issuer, repeatedly tapping the market, for large and rather standardized issues. The corporate bond market involves a large number of diverse issuers, some rather small, infrequently tapping the market, often for non-standard bonds. These features of the corporate bond market impact its liquidity. 

In this paper, we focus on the secondary market for corporate bonds in Europe. Our goal is to understand the workings of this market and investigate its efficiency. Does it convey adequate information to economic agents? Is it liquid enough to avoid excessive cost of funds for issuing firms?”

Members can access the research in its entirety via our archive of finished research projects