Overview
This series explains why the evolving U.S. corporate-bond market can show narrower bid-ask spreads without a comparable fall in the cost of holding liquidity. It separates immediate transaction cost from liquidity-yield compensation, then traces how dealer balance-sheet costs, electronic RFQs, and customer turnover alter inventory, order flow, and equilibrium. The calibrated normal-times results support cheaper execution but not a claim of abundant capacity or crisis resilience; evidence centers on investment-grade trades above $1 million from 2017 through 2021, excluding March 2020.
Learning outcomes
- A narrower bid-ask spread shows cheaper execution for measured trades, not frictionless liquidity.
- Dealer inventory determines which side can be served and can hide opposite bid and ask changes.
- Electronic RFQs can lower transaction costs and spill into voice, but usable competition still depends on inventory.
- Higher turnover can raise liquidity-yield compensation while per-trade spreads remain nearly flat.
- In the combined normal-times calibration, liquidity yield rises 0.87 basis points while both modeled spreads fall, not proving crisis resilience.
Keywords
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PlansFAQ
What does a narrower bid-ask spread prove about U.S. corporate-bond liquidity?
It shows that the measured customers faced a smaller immediate trading gap; it does not prove lower holding-period liquidity costs, abundant dealer capacity, or crisis resilience.
Why can U.S. corporate-bond spreads fall while liquidity compensation rises?
They measure different burdens: electronic search can reduce the cost of a completed trade, while turnover and balance-sheet constraints can raise compensation for future trading difficulty.
How do dealer balance sheets affect both sides of the bond market?
Inventory lets a dealer sell to customer-buyers, while unused balance-sheet space lets it buy from customer-sellers; shifting between them can move bid and ask prices in opposite directions.
What are the limits of the corporate-bond liquidity model?
It is a calibrated normal-times model of investment-grade trades above $1 million from January 2017 through March 2021, excluding March 2020, and it omits dealer exit, one-sided crisis flow, risk, information, and adverse selection.