Essays in empirical market microstructure

Abstract

The purpose of this thesis is to develop a deeper understanding of the structure and interconnectedness of credit markets, with a particular focus on the sterling corporate bond market. In the first chapter, I explore how corporate bond investors react to a change in yields, and how this behaviour differs in times of market-wide stress. Using proprietary sterling corporate bond transaction data, I show that insurance companies, hedge funds and asset managers are typically net buyers when corporate bond yields rise. Dealer banks clear the market by being net sellers. However, I find evidence for this behaviour reversing in times of stress. During the 2013 'taper tantrum', asset managers were net sellers of corporate bonds in response to a sharp rise in yields, potentially amplifying price changes. Second, I provide evidence for a liquidity spillover effect between CDS and bond markets. Bond trading volumes are larger for investors with CDS positions written on the debt issuer, in particular around rating downgrades. I use a quasi-natural experiment to validate these findings. The termination of CDS positions in response to new higher margin requirements leads to increasing sell volumes and decreasing buy volumes in the bonds of the reference entity. The results of the experiment therefore lend strong support to the liquidity spillover hypothesis. In the third and last chapter, I provide causal evidence that CDS mark-to-market losses lead to fire sales in the corporate bond market. I instrument for the prevalence of mark-to-market losses with the ratio of non-centrally cleared CDS contracts of an individual counterparty. The monthly bond sell volumes of investors exposed to large mark-to-market losses are three times higher compared to those of unexposed investors. Returns decrease by more than 100 bps for bonds sold by exposed investors, compared to same-issuer bonds sold by unexposed investors. My findings underline the risk of a liquidity spiral in the credit market.