Corporate Bond Liquidity During the COVID-19 Crisis

Abstract

We study liquidity conditions in the corporate bond market during the COVID-19 pandemic, and the effects of the unprecedented interventions by the Federal Reserve. We find that, at the height of the crisis, liquidity conditions deteriorated substantially, as dealers appeared unwilling to absorb corporate debt onto their balance sheets. In particular, we document that the cost of risky-principal trades increased by a factor of five, forcing traders to shift to slower, agency trades. The announcements of the Federal Reserve’s interventions coincided with substantial improvements in trading conditions: dealers began to “lean against the wind” and bid-ask spreads declined. To study the causal impact of the interventions on market liquidity, we exploit eligibility requirements for bonds to be purchased through the Fed’s corporate credit facilities. We find that, immediately after the facilities were announced, trading costs for eligible bonds improved significantly while those for ineligible bonds did not. Later, when the facilities were expanded, liquidity conditions improved for a wide range of bonds. We develop a simple theoretical framework to interpret our findings, and to estimate how the COVID-19 shock and subsequent interventions affected consumer surplus and dealer profits.