Long-term liquidity effects of large-scale asset purchase programs: Evidence from the euro covered bond market

Abstract

This study aims to improve the knowledge around extensive asset purchase programs and their impact on market liquidity. It documents that such programs can dampen liquidity. The analysis uses fixed-effects regressions and a unique dataset of global euro-denominated covered bonds, which quantitative easing has affected to a larger extent than other markets. While the start of the central bank purchases amplifies liquidity for several weeks, liquidity declines after half a year. The drop relates to the central bank’s bond inventory. It is partly mitigated by a reduction in buying, but liquidity does not fully recover. The contemporaneous flow effect of purchase program buying is initially positive, but becomes negative when liquidity deteriorates. These findings help designing policy and understanding behavioral liquidity effects.