Andreas C. Rapp – Research

Working Papers

Middlemen Matter: Corporate Bond Market Liquidity and Dealer Inventory Funding

[This paper is currently being updated]

Abstract: Corporate bond dealers build up considerable inventories for which they rely on short-term funding. I provide empirical evidence that dealers' inventory financing constraints are a crucial determinant of the costs of their liquidity provision in corporate bond markets. Constructing a unique dataset that links dealer identities with transaction prices, I show that dealer-specific financing constraints (as proxied by their CDS spreads) explain a substantial part of the variation in the inventory cost component of the effective bid-ask spread. Compared to low volatility bonds, the liquidity provision of high volatility bonds is more sensitive to inventory costs, especially during periods of funding stress. Finally, exploiting a quasi-natural experiment, I show that the relaxation of funding constraints through a Federal Reserve emergency credit facility temporarily alleviates liquidity problems among eligible dealers.

Paper [Online Appendix]

Presentations (includes scheduled): European Finance Association Doctoral Tutorial (Mannheim University)SAFE Market Microstructure Conference (Goethe University Frankfurt)Dauphine Microstructure Workshop (Université Paris-Dauphine) – Conference on "The Econometrics of Financial Markets" (Stockholm Business School) – Brown Bag Seminar at the Institut für Wirtschaftsforschung Halle (IWH)Universiteit van Amsterdam (UvA) Brown Bag Seminar – Tilburg University Brown Bag Seminar – BI Oslo Seminar – NHH Bergen Seminar – Rotterdam School of Management Seminar – UNSW Seminar – Bristol University Seminar – Aarhus University Seminar – Federal Reserve Bank of Cleveland Seminar

Downgrades, Dealer Funding Constraints, and Bond Price Pressure

[This paper is currently being updated]

Abstract: Regulatory constraints imposed on insurance companies can induce a collective need to divest downgraded bond issues. Upon a downgrade, corporate bond dealers act as middlemen and provide liquidity by absorbing temporary order-flow imbalances. Limited access to inventory financing can temporarily limit dealers’ inventory and risk-bearing capacities though and, at least in the short run, impair liquidity provision. Using insurance company transaction data, I investigate if dealer funding constraints (as proxied by their CDS spreads) amplify price declines and stall subsequent reversals of downgraded bonds. I find that bonds handled by constrained dealers (with higher CDS spreads) are associated with substantially larger and abrupt declines and slower reversals of abnormal returns around a downgrade.


Presentations (includes scheduled): Tilburg University Brown Bag Seminar

Work in Progress

Post-Trade Disclosure and its Impact on Dealer Liquidity Provision

Abstract: This paper analyzes the effects of post-trade disclosure on a dealer's trading strategy in a two-period dealership market. In period one a dealer executes a customer-dealer trade and in period two she offsets this position in inter-dealer trading. Trading with the customer allows the dealer to learn information conveyed in the order size. Without disclosure the dealer plays a pure strategy. However, with disclosure she adopts a mixed strategy that hides her information by randomizing the first-period trade with an endogenous noise component. The mixed strategy balances immediate profits from market-making in period one, against the reduction in future profits from speculating after disclosure in period two. Post-trade transparency lowers dealer profits and raises the customer's marginal costs of trading. Still, the dealer's noise component improves risk sharing of the customer's endowment shock. While customer welfare is improved with post-trade disclosure if both the customer and the dealer obtain signals with high and sufficiently close precision, no regime universally dominates.

Presentations (includes scheduled): Tilburg University Brown Bag Seminar