Working Paper: NBER ID: w23512
Authors: Efraim Benmelech; Nittai K. Bergman
Abstract: Credit market freezes in which debt issuance declines dramatically and market liquidity evaporates are typically observed during financial crises. In the financial crisis of 2008-09, the structured credit market froze, issuance of corporate bonds declined, and secondary credit markets became highly illiquid. In this paper we analyze liquidity in bond markets during financial crises and compare two main theories of liquidity in markets: (1) asymmetric information and adverse selection, and (2) heterogenous beliefs. Analyzing the 1873 financial crisis as well as the 2008-09 crisis, we find that when bond value deteriorates, bond illiquidity increases, consistent with an adverse selection model of the information sensitivity of debt contracts. While we show that the adverse-selection model of debt liquidity explains a large portion of the rise in illiquidity, we find little support for the hypothesis that opinion dispersion explains illiquidity in financial crises.
Keywords: credit markets; liquidity; financial crises; asymmetric information; adverse selection
JEL Codes: G01; G12; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| bond default risk increase (H74) | bond value deterioration (G12) |
| bond value deterioration (G12) | adverse selection (D82) |
| adverse selection (D82) | bond illiquidity (G12) |
| opinion dispersion (D80) | bond illiquidity (G12) |
| bond value deterioration (G12) | bond illiquidity (G12) |
| bond prices (G12) | liquidity (E41) |