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Cross-market liquidity and dealer profitability: Evidence from the bond and CDS markets

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  • Aramonte, Sirio
  • Szerszeń, Paweł J.

Abstract

We study how the credit desk profitability of U.S. dealers that trade corporate bonds and single-name credit default swaps (CDS) affects the level and correlation of liquidity in these two markets. Supervisory datasets allow us to identify the dealers involved in each transaction and to observe their daily profit and loss (P&L). We find that profitability is important for bond liquidity and for liquidity correlation. Through the lens of a stylized model, we highlight that the impact of P&L on liquidity correlation depends on the interaction between profitability and inventory pressure driven by liquidity demand correlation. The interaction is richer when market stress is low, which has implications for measuring the impact of P&L on liquidity correlation, especially for complex intermediaries. For these institutions, inventory pressure arguably also reflects variables that are difficult to measure, like risk offsetting across business lines, but that are crucial to understanding the dynamics of liquidity comovement.

Suggested Citation

  • Aramonte, Sirio & Szerszeń, Paweł J., 2020. "Cross-market liquidity and dealer profitability: Evidence from the bond and CDS markets," Journal of Financial Markets, Elsevier, vol. 51(C).
  • Handle: RePEc:eee:finmar:v:51:y:2020:i:c:s1386418120300288
    DOI: 10.1016/j.finmar.2020.100559
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    More about this item

    Keywords

    Bonds; Credit default swaps; Liquidity provision; Dealer profitability;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • 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

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