- Title
- Liquidity in the secondary corporate loan market
- Creator
- Anthony, John E.
- Relation
- University of Newcastle Research Higher Degree Thesis
- Resource Type
- thesis
- Date
- 2017
- Description
- Research Doctorate - Doctor of Philosophy (PhD)
- Description
- Of recent interest to academics, policy makers and practitioners is the role that liquidity plays in market outcomes. The aim of this thesis is to explore the measurement and cross-sectional drivers of liquidity, as well as the impact of liquidity risk, in the U.S. secondary corporate loan market (herein loan market). The loan market is a dealer-driven and relatively opaque over the counter market. It is also a relatively illiquid market, yet trading volumes are economically significant, totalling USD 628 billion in 2014. Importantly, since 2008 additional liquidity data has become available on the loan market. The thesis comprises three empirical studies. The first study begins with an examination of alternative measures of liquidity, which is followed by an investigation of liquidity risk and its drivers. Principal component analysis and canonical correlations analysis are used to determine the most effective measure of liquidity in the loan market. I find that the bid-ask spread and a measure of quote dispersion are the most effective measures of liquidity, with a preference for the bid-ask spread due to its wide applicability and ease of calculation. In Study 1, liquidity commonality, a common measure of liquidity risk, is used to examine liquidity risk in the loan market, and the extent to which any liquidity risk varies over time. Liquidity commonality shows an 18-fold increase during the 2007-2009 global financial crisis over its pre-crisis level, implying substantial variation in liquidity risk across market states. Substantial variation in liquidity commonality is also consistent with the vulnerability of the loan market to weakness in the banking and shadow-banking sectors. There is some evidence that liquidity risk in the loan market is decreasing in funding liquidity, consistent with supply-driven theoretical explanations such as Brunnermeier and Pedersen (2009). The findings are robust to the use of quote dispersion as an alternative measure of liquidity. If liquidity has an important impact in loan markets, it is critical that we understand why some loans are more liquid than others, which I examine in Study 2. The starting point is the liquidity drivers established in both the theoretical and empirical literature, including inventory costs, adverse selection costs and dealer competition. In particular, I focus on any economic rents accrued by dealers, which may be more significant in less transparent dealer driven markets. A key aspect of the analysis is the ability to examine “paired” loans; loans issued by the same borrower on the same day with identical credit ratings. This is an alternative to the asset matching methods often used in the literature, and provides the opportunity to test the direct effect of dealer market power on spreads. High dealer concentration in the loan market increases bid-ask spreads by 12-14 basis points, equivalent to $672 million of additional transaction costs per annum. This does not imply that alterative market structures or increased transparency will eliminate economic rents, rather it offers context for examining the potential costs and benefits of alternative structures or reporting requirements. Further, there is no evidence that the ability of dealers to extract economic rents is moderated by the ability of investors to access willing counterparties directly. Consistent with theoretical predictions, inventory costs are a key driver of bid-ask spreads. There is weak evidence that bid-ask spreads are increasing in adverse selection costs, although the impact is limited to higher quality loans. Again, the results are robust to the use of dispersion as an alternative measure of liquidity. Finally, the impact of shocks to liquidity and liquidity risk on yields in the loan market are examined. Liquidity shocks are disentangled from shocks to default risk using a novel method that extends Bali, Peng, Shen, and Tang (2014). Loans that experience shocks to either liquidity or default risk experience ongoing price declines, complementing evidence presented elsewhere of price momentum in loan markets. The prices of loans with high liquidity risk are significantly discounted when market liquidity is low, consistent with the time-varying funding liquidity constraints of financial intermediaries. There is mixed evidence of a liquidity premium that is sustainable outside of periods of low market liquidity. This result is consistent with the time-varying nature of liquidity risk, and various other features of the loan market. For example, loans are typically callable and have limited scope to trade significantly above par. The results are also consistent with Acharya et al. (2013), who show that liquidity risk is conditional on stress regimes and may explain why previous studies that have examined the unconditional effect of liquidity risk in the loan market have found that liquidity risk is not priced (Ehsani and Beyhaghi, 2015). In keeping with a close link between high risk debt markets and equity markets, there is evidence that equity market risk is priced in the loan market, an important consideration for investors when considering portfolio diversification strategies.
- Subject
- liquidity; secondary corporate loan market; counter market; liquidity risk
- Identifier
- http://hdl.handle.net/1959.13/1337724
- Identifier
- uon:27893
- Rights
- Copyright 2017 John E. Anthony
- Language
- eng
- Full Text
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