Funding Constraints and Market Illiquidity in the European Treasury Bond Market

Financial markets routinely experience a variety of frictions that hinder their efficient functioning by impacting price formation. These frictions are usually due to how trading is organized in a market, regulatory constraints, or trading capital. EconPol expert Sophie Moinas (TSE) and her co-authors propose an empirical investigation of the dynamic relationships between funding and market illiquidity measures in the European Treasury bond market. They find that funding illiquidity shocks affect bond market illiquidity and of a weaker, but significant, reverse feedback effect. Their analysis also shows that the responses of individual bonds' market illiquidity to funding illiquidity shocks increase with bond duration, the credit risk of the issuer, and with haircuts.