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An Empirical Analysis of Liquidity and Order Flow in the Brokered Interdealer Market for Government of Canada Bonds

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Author Info

  • Chris D'Souza
  • Charles Gaa
  • Jing Yang

Abstract

The authors empirically measure Canadian bond market liquidity using a number of indicators proposed in the literature and detail, for the first time, price and trade dynamics in the Government of Canada secondary bond market. They find, consistent with Inoue (1999), that the Canadian brokered interdealer fixed-income market is relatively liquid for its size. Liquidity measures are analyzed relative to each other and across securities, and intraday patterns are identified. The authors' results show that trading activity is positively correlated with price volatility, and that signed order flow is significant in explaining contemporaneous high-frequency price movements. They find evidence that trading activity is positively related to liquidity measures in some markets, which suggests that indicators such as trade frequency and trading volume, despite certain drawbacks, can be seen as useful proxies for liquidity. The authors also document Canadian participants' prevalent use of an order expansion protocol, whereby order size can be negotiated upward once a trade has been initiated; although Boni and Leach (2002) identify this practice as consistent with a market where there is relatively strong concern regarding information asymmetry, the authors observe no consistent link between the frequency of its use and observations of trading activity, market liquidity, or price volatility.

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Bibliographic Info

Paper provided by Bank of Canada in its series Working Papers with number 03-28.

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Length: 52 pages
Date of creation: 2003
Date of revision:
Handle: RePEc:bca:bocawp:03-28

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Keywords: Financial markets; Market structure and pricing;

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References

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  1. Michael Fleming & Asani Sarkar, 1999. "Liquidity in U.S. Treasury Spot and Futures Markets," CGFS Papers chapters, in: Bank for International Settlements (ed.), Market Liquidity: Research Findings and Selected Policy Implications, volume 11, pages 1-14 Bank for International Settlements.
  2. Tarun Chordia & Asani Sarkar & Avanidhar Subrahmanyam, 2003. "An empirical analysis of stock and bond market liquidity," Staff Reports 164, Federal Reserve Bank of New York.
  3. Michael W. Brandt & Kenneth A. Kavajecz, 2003. "Price Discovery in the U.S. Treasury Market: The Impact of Orderflow and Liquidity on the Yield Curve," NBER Working Papers 9529, National Bureau of Economic Research, Inc.
  4. Hirotaka Inoue, 1999. "The Structure of Government Securities Markets in G10 Countries: Summary of Questionnaire Results," CGFS Papers chapters, in: Bank for International Settlements (ed.), Market Liquidity: Research Findings and Selected Policy Implications, volume 11, pages 1-22 Bank for International Settlements.
  5. Michael J. Fleming, 2002. "Are larger Treasury issues more liquid? Evidence from bill reopenings," Proceedings, Federal Reserve Bank of Cleveland, pages 707-739.
  6. Evans, Martin D. & Lyons, Richard K., 1999. "Order Flow and Exchange Rate Dynamics," Research Program in Finance, Working Paper Series qt0dh1c16w, Research Program in Finance, Institute for Business and Economic Research, UC Berkeley.
  7. Bank for International Settlements, 1999. "Market Liquidity: Research Findings and Selected Policy Implications," CGFS Papers, Bank for International Settlements, number 11, January.
  8. Benjamin Cohen & Hyun Song Shin, 2002. "Positive feedback trading under stress: evidence from the US Treasury securities market," BIS Papers chapters, in: Bank for International Settlements (ed.), Market functioning and central bank policy, volume 12, pages 148-180 Bank for International Settlements.
  9. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
  10. Madhavan, Ananth & Smidt, Seymour, 1993. " An Analysis of Changes in Specialist Inventories and Quotations," Journal of Finance, American Finance Association, vol. 48(5), pages 1595-1628, December.
  11. Toni Gravelle, 2002. "The Microstructure of Multiple-Dealer Equity and Government Securities Markets: How They Differ," Working Papers 02-9, Bank of Canada.
  12. Amihud, Yakov & Mendelson, Haim & Lauterbach, Beni, 1997. "Market microstructure and securities values: Evidence from the Tel Aviv Stock Exchange," Journal of Financial Economics, Elsevier, vol. 45(3), pages 365-390, September.
  13. Michael J. Fleming, 1997. "The round-the-clock market for U.S. Treasury securities," Economic Policy Review, Federal Reserve Bank of New York, issue Jul, pages 9-32.
  14. Karpoff, Jonathan M., 1987. "The Relation between Price Changes and Trading Volume: A Survey," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 22(01), pages 109-126, March.
  15. Toni Gravelle & Richhild Moessner, 2001. "Reactions of Canadian Interest Rates to Macroeconomic Announcements: Implications for Monetary Policy Transparency," Working Papers 01-5, Bank of Canada.
  16. Yakov Amihud & Haim Mendelson & Beni Lauterbach, 1997. "Market Microstructure and Securities Values: Evidence from the Tel Aviv Stock Exchange," New York University, Leonard N. Stern School Finance Department Working Paper Seires 98-004, New York University, Leonard N. Stern School of Business-.
  17. Andersen, Torben G, 1996. " Return Volatility and Trading Volume: An Information Flow Interpretation of Stochastic Volatility," Journal of Finance, American Finance Association, vol. 51(1), pages 169-204, March.
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Citations

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Cited by:
  1. Natasha Khan, 2007. "Impact of Electronic Trading Platforms on the Brokered Interdealer Market for Government of Canada Benchmark Bonds," Working Papers 07-5, Bank of Canada.
  2. Chris D'Souza & Charles Gaa, 2004. "The Effects of Economic News on Bond Market Liquidity," Working Papers 04-16, Bank of Canada.
  3. Thanasis N. Christodoulopoulos & Ioulia Grigoratou, 2005. "Measuring Liquidity in the Greek Government Securities Market," Working Papers 23, Bank of Greece.
  4. Yalin Gündüz & Torsten Lüdecke & Marliese Uhrig-Homburg, 2007. "Trading Credit Default Swaps via Interdealer Brokers," Journal of Financial Services Research, Springer, vol. 32(3), pages 141-159, December.
  5. Chris D'Souza & Ingrid Lo & Stephen Sapp, 2007. "Price Formation and Liquidity Provision in Short-Term Fixed Income Markets," Working Papers 07-27, Bank of Canada.
  6. Christopher Chung & Bryan Campbell & Scott Hendry, 2007. "Price Discovery in Canadian Government Bond Futures and Spot Markets," Working Papers 07-4, Bank of Canada.
  7. Coluzzi, Chiara & Ginebri, Sergio & Turco, Manuel, 2008. "Measuring and Analyzing the Liquidity of the Italian Treasury Security Wholesale Secondary Market," Economics & Statistics Discussion Papers esdp08044, University of Molise, Dept. EGSeI.

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