IDEAS home Printed from https://ideas.repec.org/p/srk/srkwps/20240.html
   My bibliography  Save this paper

The market liquidity of interest rate swaps

Author

Listed:
  • Boudiaf, Ismael Alexander
  • Scheicher, Martin
  • Frieden, Immo

Abstract

This paper studies market liquidity in interest rate swaps (IRS) before and during the global tightening of monetary policy. IRS constitute the single largest derivatives segment globally. Banks and Pension Funds extensively rely on IRS to hedge interest rate risk. Hence, providing an understanding of this market and the drivers of market liquidity is a key research question in the current market context. We use price and volume data from around 338.000 trades in the most active long-horizon swap contract denominated in EUR to construct seven liquidity measures. Taking a comprehensive approach, we ap-ply linear regressions to determine the drivers of variation in liquidity. Our liquidity measures are significantly related to monetary policy, market-wide fixed income liquidity, EURIBOR rate volatility and Dealer behaviour. Indicators for generic market stress such as VIX which are often documented in the literature are not strongly connected to IRS trading conditions. JEL Classification: G12, G15

Suggested Citation

  • Boudiaf, Ismael Alexander & Scheicher, Martin & Frieden, Immo, 2024. "The market liquidity of interest rate swaps," ESRB Working Paper Series 20240, European Systemic Risk Board.
    • Handle: RePEc:srk:srkwps:20240
    Note: 152802
    as

    Download full text from publisher

    File URL: https://www.esrb.europa.eu//pub/pdf/wp/esrb.wp1xx.en.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. D’Errico, Marco & Battiston, Stefano & Peltonen, Tuomas & Scheicher, Martin, 2018. "How does risk flow in the credit default swap market?," Journal of Financial Stability, Elsevier, vol. 35(C), pages 53-74.
    2. Abad, Jorge & Aldasoro, Iñaki & Aymanns, Christoph & D'Errico, Marco & Hoffmann, Peter & Langfield, Sam & Neychev, Martin & Roukny, Tarik & Rousová, Linda, 2016. "Shedding light on dark markets: First insights from the new EU-wide OTC derivatives dataset," ESRB Occasional Paper Series 11, European Systemic Risk Board.
    3. Grace Xing Hu & Jun Pan & Jiang Wang, 2013. "Noise as Information for Illiquidity," Journal of Finance, American Finance Association, vol. 68(6), pages 2341-2382, December.
    4. Markus K. Brunnermeier & Lasse Heje Pedersen, 2009. "Market Liquidity and Funding Liquidity," The Review of Financial Studies, Society for Financial Studies, vol. 22(6), pages 2201-2238, June.
    5. Tobias Adrian & John Kiff & Hyun Song Shin, 2018. "Liquidity, Leverage, and Regulation 10 Years After the Global Financial Crisis," Annual Review of Financial Economics, Annual Reviews, vol. 10(1), pages 1-24, November.
    6. Mr. Tonny Lybek & Mr. Abdourahmane Sarr, 2002. "Measuring Liquidity in Financial Markets," IMF Working Papers 2002/232, International Monetary Fund.
    7. Huang, Roger D & Stoll, Hans R, 1997. "The Components of the Bid-Ask Spread: A General Approach," The Review of Financial Studies, Society for Financial Studies, vol. 10(4), pages 995-1034.
    8. Péter Kondor & Dimitri Vayanos, 2019. "Liquidity Risk and the Dynamics of Arbitrage Capital," Journal of Finance, American Finance Association, vol. 74(3), pages 1139-1173, June.
    9. 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).
    10. Chordia, Tarun & Roll, Richard & Subrahmanyam, Avanidhar, 2000. "Commonality in liquidity," Journal of Financial Economics, Elsevier, vol. 56(1), pages 3-28, April.
    11. O'Hara, Maureen & Zhou, Xing (Alex), 2021. "Anatomy of a liquidity crisis: Corporate bonds in the COVID-19 crisis," Journal of Financial Economics, Elsevier, vol. 142(1), pages 46-68.
    12. Wenxin Du & Alexander Tepper & Adrien Verdelhan, 2018. "Deviations from Covered Interest Rate Parity," Journal of Finance, American Finance Association, vol. 73(3), pages 915-957, June.
    13. Di Maggio, Marco & Kermani, Amir & Song, Zhaogang, 2017. "The value of trading relations in turbulent times," Journal of Financial Economics, Elsevier, vol. 124(2), pages 266-284.
    14. Darrell Duffie & Nicolae Gârleanu & Lasse Heje Pedersen, 2007. "Valuation in Over-the-Counter Markets," The Review of Financial Studies, Society for Financial Studies, vol. 20(6), pages 1865-1900, November.
    15. Duffie, Darrell & Singleton, Kenneth J, 1999. "Modeling Term Structures of Defaultable Bonds," The Review of Financial Studies, Society for Financial Studies, vol. 12(4), pages 687-720.
    16. Adrian, Tobias & Kiff, John & Shin, Hyun Song, 2018. "Liquidity, Leverage, and Regulation Ten Years after the Global Financial Crisis," CEPR Discussion Papers 13350, C.E.P.R. Discussion Papers.
    17. He, Zhiguo & Kelly, Bryan & Manela, Asaf, 2017. "Intermediary asset pricing: New evidence from many asset classes," Journal of Financial Economics, Elsevier, vol. 126(1), pages 1-35.
    18. Boudiaf, Ismael Alexander & Scheicher, Martin & Vacirca, Francesco, 2023. "CCP initial margin models in Europe," Occasional Paper Series 314, European Central Bank.
    19. Bicu-Lieb, Andreea & Chen, Louisa & Elliott, David, 2020. "The leverage ratio and liquidity in the gilt and gilt repo markets," Journal of Financial Markets, Elsevier, vol. 48(C).
    20. Altavilla, Carlo & Motto, Roberto, 2020. "How do financial markets react to monetary policy signals?," Research Bulletin, European Central Bank, vol. 73.
    21. 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.
    22. Dalla Fontana, Silvia & Holz auf der Heide, Marco & Pelizzon, Loriana & Scheicher, Martin, 2019. "The anatomy of the euro area interest rate swap market," Working Paper Series 2242, European Central Bank.
    23. Roll, Richard, 1984. "A Simple Implicit Measure of the Effective Bid-Ask Spread in an Efficient Market," Journal of Finance, American Finance Association, vol. 39(4), pages 1127-1139, September.
    24. Nils Friewald & Florian Nagler, 2019. "Over‐the‐Counter Market Frictions and Yield Spread Changes," Journal of Finance, American Finance Association, vol. 74(6), pages 3217-3257, December.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Fontana, Silvia Dalla & Holz auf der Heide, Marco & Pelizzon, Loriana & Scheicher, Martin, 2019. "The anatomy of the euro area interest rate swap market," SAFE Working Paper Series 255, Leibniz Institute for Financial Research SAFE.
    2. Lewis, Kurt F. & Longstaff, Francis A. & Petrasek, Lubomir, 2021. "Asset mispricing," Journal of Financial Economics, Elsevier, vol. 141(3), pages 981-1006.
    3. Scheicher, Martin, 2023. "Intermediation in US and EU bond and swap markets: stylised facts, trends and impact of the coronavirus (COVID-19) crisis in March 2020," ESRB Occasional Paper Series 24, European Systemic Risk Board.
    4. Darrell Duffie & Michael Fleming & Frank Keane & Claire Nelson & Or Shachar & Peter Van Tassel, 2023. "Dealer capacity and US Treasury market functionality," BIS Working Papers 1138, Bank for International Settlements.
    5. Goldstein, Michael A. & Namin, Elmira Shekari, 2023. "Corporate bond liquidity and yield spreads: A review," Research in International Business and Finance, Elsevier, vol. 65(C).
    6. Auer, Benjamin R. & Rottmann, Horst, 2019. "Have capital market anomalies worldwide attenuated in the recent era of high liquidity and trading activity?," Journal of Economics and Business, Elsevier, vol. 103(C), pages 61-79.
    7. Zhiguo He & Paymon Khorrami & Zhaogang Song, 2022. "Commonality in Credit Spread Changes: Dealer Inventory and Intermediary Distress," The Review of Financial Studies, Society for Financial Studies, vol. 35(10), pages 4630-4673.
    8. Jonathan Goldberg & Yoshio Nozawa, 2021. "Liquidity Supply in the Corporate Bond Market," Journal of Finance, American Finance Association, vol. 76(2), pages 755-796, April.
    9. Cenedese, Gino & Ranaldo, Angelo & Vasios, Michalis, 2020. "OTC premia," Journal of Financial Economics, Elsevier, vol. 136(1), pages 86-105.
    10. Thomas Paul & Thomas Walther & André Küster-Simic, 2022. "Empirical analysis of the illiquidity premia of German real estate securities," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 36(2), pages 203-260, June.
    11. Czech, Robert, 2021. "Credit default swaps and corporate bond trading," Journal of Financial Intermediation, Elsevier, vol. 48(C).
    12. Péter Kondor & Dimitri Vayanos, 2019. "Liquidity Risk and the Dynamics of Arbitrage Capital," Journal of Finance, American Finance Association, vol. 74(3), pages 1139-1173, June.
    13. Harald Hau & Peter Hoffmann & Sam Langfield & Yannick Timmer, 2021. "Discriminatory Pricing of Over-the-Counter Derivatives," Management Science, INFORMS, vol. 67(11), pages 6660-6677, November.
    14. O’Sullivan, Conall & Papavassiliou, Vassilios G., 2020. "On the term structure of liquidity in the European sovereign bond market," Journal of Banking & Finance, Elsevier, vol. 114(C).
    15. Nina Karnaukh & Angelo Ranaldo & Paul Söderlind, 2015. "Understanding FX Liquidity," The Review of Financial Studies, Society for Financial Studies, vol. 28(11), pages 3073-3108.
    16. Gino Cenedese & Pasquale Della Corte & Tianyu Wang, 2021. "Currency Mispricing and Dealer Balance Sheets," Journal of Finance, American Finance Association, vol. 76(6), pages 2763-2803, December.
    17. Guimaraes, Rodrigo & Pinter, Gabor & Wijnandts, Jean-Charles, 2023. "The liquidity state-dependence of monetary policy transmission," Bank of England working papers 1045, Bank of England.
    18. Goldberg, Jonathan, 2020. "Liquidity supply by broker-dealers and real activity," Journal of Financial Economics, Elsevier, vol. 136(3), pages 806-827.
    19. Du, Wenxin & Hebert, Benjamin & Wang, Amy, 2019. "Are Intermediary Constraints Priced?," Research Papers 3770, Stanford University, Graduate School of Business.
    20. Gian Piero Aielli & Davide Pirino, 2023. "Funding Liquidity and Stocks’ Market Liquidity: Structural Estimation From High-Frequency Data," CEIS Research Paper 568, Tor Vergata University, CEIS, revised 28 Nov 2023.

    More about this item

    Keywords

    fixed income; liquidity; market structure; swap;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:srk:srkwps:20240. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Official Publications (email available below). General contact details of provider: https://edirc.repec.org/data/esrbede.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.