Liberty Street Economics
October 07, 2015

Changes in the Returns to Market Making

Fourth in a six-part series

Since the financial crisis, major U.S. banking institutions have increased their capital ratios in response to tighter capital requirements. Some market analysts have asserted that the higher capital and liquidity requirements are driving up the costs of market making and reducing market liquidity. If regulations were, in fact, increasing the cost of market making, one would expect to see a rise in the expected returns to that activity. In this post, we estimate market-making returns in equity and corporate bond markets to assess the impact of regulations.

October 06, 2015

Has Liquidity Risk in the Treasury and Equity Markets Increased?

Third in a six-part series

Market participants have argued that market liquidity has deteriorated since the financial crisis. However, inspection of common metrics such as bid-ask spreads, market depth, and price impact do not show pronounced reductions in liquidity compared with precrisis levels. In this post, we argue that recent changes in liquidity conditions may best be described in terms of heightened liquidity risk, as opposed to general declines in liquidity levels. We propose a measure that shows liquidity risk has risen in equity and Treasury markets and discuss some factors behind the increase.

Posted by Blog Author at 7:05 AM in Financial Markets | Permalink | Comments ( 1 )

Has Liquidity Risk in the Corporate Bond Market Increased?

Second in a six-part series
Recent commentary suggests concern among market participants about corporate bond market liquidity. However, we showed in our previous post that liquidity in the corporate bond market remains ample. One interpretation is that liquidity risk might have increased, even as the average level of liquidity remains sanguine. In this post, we propose a measure of liquidity risk in the corporate bond market and analyze its evolution over time.

Posted by Blog Author at 7:00 AM in Financial Markets | Permalink | Comments ( 0 )

October 05, 2015

Has U.S. Corporate Bond Market Liquidity Deteriorated?

First in a six-part series
Commentators have argued that market liquidity has deteriorated in recent years as regulatory changes have reduced banks’ ability and willingness to make markets. In the corporate debt market, dealer positions, which are considered essential to good liquidity, have indeed declined, even as issuance and outstanding debt have increased. But is there evidence of reduced market liquidity? In previous posts, we discussed these issues in the context of the U.S. Treasury securities market. In this post, we focus on the U.S. corporate bond market, reviewing both price- and quantity-based liquidity measures, including trading volume, trade size, bid-ask spreads, and price impact.

Introduction to a Series on Market Liquidity: Part 2

Market participants and policymakers have raised concerns about the potential adverse effects of financial regulation on market liquidity—the ability to buy and sell securities quickly, at any time, at minimal cost. Market liquidity supports the efficient allocation of capital through financial markets, which is a catalyst for sustainable economic growth. Changes in market liquidity, whether due to regulation or other forces, are therefore of great interest to policymakers and market participants alike.

Posted by Blog Author at 11:00 AM in Financial Markets | Permalink | Comments ( 0 )

October 02, 2015

Crisis Chronicles: Defensive Suspension and the Panic of 1857

Sometimes the world loses its bearings and the best alternative is a timeout. Such was the case during the Panic of 1857, which started when a prestigious bank in New York City collapsed, making all banks suddenly suspect. Banks, fearing a run on their gold reserves, started calling in loans from commercial firms and brokers, leading to asset sales at fire-sale prices and bankruptcies. By mid-October, banks in Philadelphia and New York suspended convertibility, meaning they would not allow gold to be withdrawn from their vaults even while all other banking services continued. Suspension then swept the nation as part of a defensive strategy, supported by local business interests, to prevent the Panic from spreading. While the suspensions appeared successful and few banks ended up failing, President Buchanan was outraged by what he viewed as yet another corrupt banking practice. He proposed making suspension a “death sentence” for banks as a draconian incentive to encourage safer banking practices. In this edition of Crisis Chronicles, we describe the Panic of 1857 and explain why businesses pushed for national suspension to save themselves.

October 01, 2015

Introducing Our New App: Economic Research Tracker


Our experiment in blogging began four years ago, when we launched Liberty Street Economics. Now, with more than 600 posts published, the blog platform has become a central way for us to share our research with a wide audience. To further expand access to the blog, we’re excited to bring readers a new option for keeping up with our work—the Economic Research Tracker for Apple iPad.

Posted by Blog Author at 11:06 AM in Macroecon | Permalink | Comments ( 2 )

September 30, 2015

Natural Experiment Sheds Light on the Market Effects of Herding


Pension funds are expected to behave in a patient, countercyclical manner, making the most of low valuations over the business cycle to achieve high returns. Such behavior provides liquidity and stability to the financial system. However, this belief has come under question. A large theoretical literature has emerged which looks at how short-term considerations affecting these institutional investors might arise from relative performance concerns or from the influence of other incentives introduced by market and regulatory monitoring. Such considerations might incentivize fund managers to mimic others and herd toward common assets. Given the sizable wealth under management by these investors, such herding behavior can potentially have large effects on asset prices both in the short and long run.

September 28, 2015

Same Name, New Businesses: Evolution in the Bank Holding Company


When we think of banks, we typically have in mind our local bank branch that stores deposits and issues mortgages or business loans. Prima facie there is nothing wrong with this image. After all, there are still almost 6,000 unique commercial banks in the United States that specialize in deposit-taking and loan-making; when we include thrifts and credit unions, this number more than doubles. What we typically forget, however, is that most commercial banks are subsidiaries of larger bank holding companies (BHCs), and in fact nearly all commercial bank assets fall under such BHCs. This post presents a first in-depth analysis of the evolving organizational structure of U.S. bank holding companies over the last twenty-five years. We present a unique new database that details BHC structure at a level previously unavailable in any systematic way.

Posted by Blog Author at 7:00 AM in Financial Institutions | Permalink | Comments ( 3 )

September 23, 2015

How Much Do Inflation Expectations Matter for Inflation Dynamics?

Inflation dynamics are often described by some form of the Phillips curve. Named after A. W. Phillips, the British economist whose study of U.K. wage and unemployment data laid the groundwork, the Phillips curve denotes an inverse relationship between inflation and some measure of economic slack. A much-discussed issue in the literature is how forward-looking this relationship is. In this post, we address this question using a flexible version of the New Keynesian Phillips curve (NKPC) to illustrate the key role that expectations play in inflation dynamics.

Posted by Blog Author at 7:00 AM in Macroecon , Monetary Policy | Permalink | Comments ( 0 )

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