Investors as a Liquidity Backstop in Corporate Bond Markets

Investors provide liquidity to dealers in the corporate bond market, reducing transaction costs across trades. This is especially valuable during periods of stress. For instance, during the March 2020 Dash-for-Cash, transaction costs rose by 38% in bonds where investors acting as liquidity providers for dealers exited. The composition of dealers’ networks of liquidity suppliers matters: bonds relying on flexible mandate clients, such as hedge funds, are more resilient to liquidity strains. Dealers sustain their liquidity networks by offering discounts to clients in these networks, even when those clients demand liquidity. Overall, liquidity networks act as insurance for dealers. They are used infrequently but enhance resilience against increases in intermediation costs.