What Causes Seasonality in the Secondary Market Liquidity of Covered Bonds?

Abstract

This paper finds that window dressing, bypass opportunities, market sentiment and index adjustments drive seasonal bond market liquidity effects. It uses a unique data set that combines a number of recurring event types. After controlling for other seasonal factors, liquidity is lower prior to quarter ends, which is attributed to market makers’ window dressing. Seasonal liquidity effects are smaller in case investors can bypass secondary market venues, and market sentiment influences both the direction and the size of most seasonal effects. Additions to an index spur the liquidity of the bond included, and index adjustments are also important for the liquidity of other bonds, that have been issued by the same institution. These results give important advice for the trading of market participants, they explain why the primary market is essential for secondary venues and why too much regulation can be detrimental to market capacity.