FRIC/FI Seminar with Or Shachar, Federal Reserve Bank of New York

Center for Financial Frictions and the Department of Finance are proud to announce the upcoming seminar with Or Shachar, Federal Reserve Bank of New York

Title: Did Liquidity Providers Become Liquidity Seekers?

Abstract. The misalignment between corporate bond and credit default swap (CDS) spreads (i.e. CDS-bond basis) during the 07/09 financial crisis is often attributed to corporate bond dealers' shedding off their inventory, right when liquidity was scarce. This paper documents evidence against this widespread perception. In the months following Lehman's collapse, dealers, including proprietary trading desks in investment banks, provided liquidity in response to the large selling of clients. Corporate bonds inventory of dealers rose sharply as a result. Although providing liquidity, limits-to-arbitrage, possibly in the form of limited capital, obstructed the convergence of the basis. We further show that unwinding of pre-crisis "basis trades" by hedge-funds is the main driver for the large negative basis. Price drops following the Lehman's collapse were concentrated among bonds with available CDS contracts and high activity in basis trades. Overall, our results indicate that hedge-funds who serve as alternative liquidity providers at times, not dealers, caused the disruption in the credit market.

(Joint work with Jaewon Choi)

Location

Solbjerg Plads 3, 2000 Frederiksberg

SP207