An anatomy of the 2022 gilt market crisis

We use transaction-level data on the UK government bond, repo and interest-rate swap markets to analyse market liquidity, investor behaviour and price dynamics during the market disruptions in September and October 2022. We provide a detailed account of how selling pressure in gilt markets – due to deteriorating derivative and repo positions of liability-driven investors (LDI) – led to evaporating market liquidity, especially in long-dated conventional gilts and index-linked gilts. We find that firms in the LDI-pension-insurance (LDI-PI) sector who had larger repo and swap exposure before the crisis sold more gilts during the crisis (while hedge funds were compensated for providing liquidity to the LDI-PI sector). Transaction costs in bond markets quickly soared, particularly for smaller trades, for trades at smaller dealers and for trades of non-LDI-PI investors too. The aggregate dispersion of transaction prices more than doubled in a matter of days, and price dispersion across primary dealers remained significant throughout the crisis, suggestive of tightened constraints on the intermediary sector. While the episode started with the forced selling by the LDI-PI sector, our results point to large costs on other market segments as well, consistent with the contagious nature of illiquidity.