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Sovereign credit risk, liquidity, and European Central Bank intervention: Deus ex machina?

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  • Pelizzon, Loriana
  • Subrahmanyam, Marti G.
  • Tomio, Davide
  • Uno, Jun

Abstract

We examine the dynamic relation between credit risk and liquidity in the Italian sovereign bond market during the eurozone crisis and the subsequent European Central Bank (ECB) interventions. Credit risk drives the liquidity of the market. A 10% change in the credit default swap (CDS) spread leads to a 13% change in the bid-ask spread, the relation being stronger when the CDS spread exceeds 500 basis points. The Long-Term Refinancing Operations of the ECB weakened the sensitivity of market makers’ liquidity provision to credit risk, highlighting the importance of funding liquidity measures as determinants of market liquidity.

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  • Pelizzon, Loriana & Subrahmanyam, Marti G. & Tomio, Davide & Uno, Jun, 2016. "Sovereign credit risk, liquidity, and European Central Bank intervention: Deus ex machina?," Journal of Financial Economics, Elsevier, vol. 122(1), pages 86-115.
    • Handle: RePEc:eee:jfinec:v:122:y:2016:i:1:p:86-115
    DOI: 10.1016/j.jfineco.2016.06.001
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    More about this item

    Keywords

    Liquidity; Credit risk; Eurozone sovereign bonds; Financial crisis; MTS bond market;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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