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Staff Working Paper No. 665: Dealer intermediation, market liquidity and the impact of regulatory reform

Author

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  • Baranova, Yuliya

    (Bank of England)

  • Liu, Zijun

    (Bank of England)

  • Shakir, Tamarah

    (Bank of England)

Abstract

We develop a model of dealer intermediation in bond markets that takes account of how changing regulatory requirements for banks since the financial crisis, in particular, the introduction of minimum leverage ratio requirements, affect the cost and ability of dealer banks to provide intermediation services. The framework considers two distinct dealer functions: that of provider of repo financing (to prospective bond market participants) and that of market-maker. The cost and ability of dealers to provide these services under different regulatory constraints determines the price impact of a given trade on the market — or the level of ‘market liquidity premia’. In the model the impact on market liquidity varies for different levels of market volatility or ‘stress’. We find that under normal market conditions estimates of corporate bond liquidity risk premia are higher under the new regulations, but also that corporate bond market liquidity is more resilient due to better-capitalised dealers continuing to intermediate markets under higher levels of market stress than pre-crisis. Mapping these changes in liquidity premia to GDP, via their impact on the cost of borrowing for corporates in the real economy, the results of the model suggest that under normal market conditions there may be a greater cost of regulation via corporate bond markets than incorporated in earlier studies. However, once offset against the benefits of greater dealer resilience, including the benefits to market functioning, there remain net benefits to new regulations.

Suggested Citation

  • Baranova, Yuliya & Liu, Zijun & Shakir, Tamarah, 2017. "Staff Working Paper No. 665: Dealer intermediation, market liquidity and the impact of regulatory reform," Bank of England working papers 665, Bank of England.
  • Handle: RePEc:boe:boeewp:0665
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    File URL: https://www.bankofengland.co.uk/-/media/boe/files/working-paper/2017/dealer-intermediation-market-liquidity-and-the-impact-of-regulatory-reform.pdf?la=en&hash=C8A03F500420F47BA3A75E7E3E733D58BB38C722
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    Citations

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    Cited by:

    1. Giovanni di Iasio & Spyridon Alogoskoufis & Simon Kordel & Dominika Kryczka & Giulio Nicoletti & Nicholas Vause, 2022. "A model of system-wide stress simulation: market-based finance and the Covid-19 event," Questioni di Economia e Finanza (Occasional Papers) 687, Bank of Italy, Economic Research and International Relations Area.
    2. Peter G. Dunne, 2019. "Positive Liquidity Spillovers from Sovereign Bond-Backed Securities," JRFM, MDPI, vol. 12(2), pages 1-25, April.
    3. Goel, Tirupam & Lewrick, Ulf & Tarashev, Nikola, 2020. "Bank capital allocation under multiple constraints," Journal of Financial Intermediation, Elsevier, vol. 44(C).
    4. Aikman, David & Beale, Daniel & Brinley-Codd, Adam & Covi, Giovanni & Hüser, Anne‑Caroline & Lepore, Caterina, 2023. "Macroprudential stress‑test models: a survey," Bank of England working papers 1037, Bank of England.
    5. Claudio Impenna & Paola Paiardini, 2019. "Informed trading in a two-tier market structure under financial distress," Discussion Papers 19-06, Department of Economics, University of Birmingham.
    6. Aikman, David & Haldane, Andrew & Hinterschweiger, Marc & Kapadia, Sujit, 2018. "Rethinking financial stability," Bank of England working papers 712, Bank of England.
    7. Rohan Arora & Guillaume Bédard-Pagé & Guillaume Ouellet Leblanc & Ryan Shotlander, 2019. "Bond Funds and Fixed-Income Market Liquidity: A Stress-Testing Approach," Technical Reports 115, Bank of Canada.
    8. Aikman, David & Chichkanov, Pavel & Douglas, Graeme & Georgiev, Yordan & Howat, James & King, Benjamin, 2019. "System-wide stress simulation," Bank of England working papers 809, Bank of England.
    9. Alessandro Schiavone, 2018. "Estimating the contagion effect through the portfolio channel using a network approach," Questioni di Economia e Finanza (Occasional Papers) 429, Bank of Italy, Economic Research and International Relations Area.

    More about this item

    Keywords

    Regulation; market liquidity; dealer intermediation; corporate bonds; cost-benefit analysis;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G29 - Financial Economics - - Financial Institutions and Services - - - Other

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