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

Sirio Aramonte and Paweł J. Szerszeń

Journal of Financial Markets, 2020, vol. 51, issue C

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.

Keywords: Bonds; Credit default swaps; Liquidity provision; Dealer profitability (search for similar items in EconPapers)
JEL-codes: G21 G23 G24 (search for similar items in EconPapers)
Date: 2020
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finmar:v:51:y:2020:i:c:s1386418120300288

DOI: 10.1016/j.finmar.2020.100559

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Journal of Financial Markets is currently edited by B. Lehmann, D. Seppi and A. Subrahmanyam

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