Understand funding liquidity and market liquidity in a regime-switching model

Chen, Louisa, Shen, Liya and Zhou, Zhiping (2021) Understand funding liquidity and market liquidity in a regime-switching model. International Journal of Finance and Economics. pp. 1-17. ISSN 1076-9307

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We investigate the time‐varying relationship of funding liquidity (FL) and market liquidity (ML) in a Markov regime‐switching model. By using a comprehensive U.S. TRACE dataset, we provide strong evidence that FL and corporate bond ML are interlinked, and their impact on each other is highly regime‐dependent. We find that FL and ML exhibit a large‐and‐positive mutual impact when money market is tight and equity market is volatile. But in normal regimes, FL is found to have a negative impact on ML with a much smaller magnitude than those in stressed regimes. Furthermore, FL is more stable than ML with less regime changes. Our article offers insight on the important mechanism by which central banks can improve ML through the funding market.

Item Type: Article
Schools and Departments: University of Sussex Business School > Accounting and Finance
SWORD Depositor: Mx Elements Account
Depositing User: Mx Elements Account
Date Deposited: 06 Jan 2021 08:50
Last Modified: 06 Jan 2021 09:00
URI: http://sro.sussex.ac.uk/id/eprint/96340

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