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Funding liquidity and market liquidity in government bonds

Prachi Deuskar and Timothy C. Johnson

Journal of Banking & Finance, 2021, vol. 129, issue C

Abstract: Using a comprehensive dataset of orders and trades in the Indian government bond market, this study presents new evidence on the effect of funding liquidity on market liquidity. We find no evidence that lower short-term interest rates – the key instruments of monetary policy – boost market liquidity. However, consistent with models that stress the role of intermediary capital, we find that market liquidity measures have a strong, positive association with short-term borrowing by primary dealers. We provide additional evidence linking these firms’ borrowing to their balance sheet strength and secondary market participation. The results suggest that localized funding conditions specific to marginal suppliers of intermediation services are more important for market liquidity than the broader economy-wide funding environment.

Keywords: Government bonds; Market liquidity; Funding liquidity; Intermediary capital (search for similar items in EconPapers)
JEL-codes: E51 G12 G23 (search for similar items in EconPapers)
Date: 2021
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DOI: 10.1016/j.jbankfin.2021.106165

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Handle: RePEc:eee:jbfina:v:129:y:2021:i:c:s0378426621001242