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Board of Governors of the Federal Reserve System (US)
Finance and Economics Discussion Series
The Volcker Rule and Market-Making in Times of Stress
Jack Bao
Maureen O'Hara
Xing Zhou
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.


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Jack Bao & Maureen O'Hara & Xing Zhou, The Volcker Rule and Market-Making in Times of Stress, Board of Governors of the Federal Reserve System (US), Finance and Economics Discussion Series 2016-102, Sep 2016.
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Keywords: Volcker Rule ; Corporate Bond Illiquidity ; Regulation ; Capital Commitment ; Dealer Inventory ; Market-Making ; Financial Crisis
DOI: 10.17016/FEDS.2016.102
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