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

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Version 2 2023-06-12, 09:39
Version 1 2023-06-09, 22:38
journal contribution
posted on 2023-06-12, 09:39 authored by Louisa ChenLouisa Chen, Liya Shen, Zhiping Zhou
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.

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Publication status

  • Published

File Version

  • Published version

Journal

International Journal of Finance and Economics

ISSN

1076-9307

Publisher

Wiley

Page range

1-17

Department affiliated with

  • Accounting and Finance Publications

Full text available

  • Yes

Peer reviewed?

  • Yes

Legacy Posted Date

2021-01-06

First Open Access (FOA) Date

2021-01-06

First Compliant Deposit (FCD) Date

2021-01-05

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