Working Paper

The Volcker Rule and Market-Making in Times of Stress

Abstract: Focusing on downgrades as stress events that drive the selling of corporate bonds, we document that the illiquidity of stressed bonds has increased after the Volcker Rule. Dealers regulated by the Rule have decreased their market-making activities while non-Volcker-affected dealers have stepped in to provide some additional liquidity. Furthermore, even Volcker-affected dealers that are not constrained by Basel III and CCAR regulations change their behavior, inconsistent with the effects being driven by these other regulations. Since Volcker-affected dealers have been the main liquidity providers, the net effect is that bonds are less liquid during times of stress due to the Volcker Rule.

Keywords: Volcker Rule; Corporate Bond Illiquidity; Regulation; Capital Commitment; Dealer Inventory; Market-Making; Financial Crisis;

JEL Classification: G14; G21; G23; G24; G28;

https://doi.org/10.17016/FEDS.2016.102

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2016-09

Number: 2016-102

Pages: 45 pages