Positive Liquidity Spillovers from Sovereign Bond-Backed Securities
Abstract
:1. Introduction
2. Hedging, Arbitrage and Diversification
3. Microstructure Literature
4. Methodology
4.1. Derivation of SBBS Yields
4.2. Methodology for Optimal Hedge Selection
4.3. Measuring Out-Of-Sample Hedge Effectiveness
5. Results
5.1. Effectiveness of Hedging without Diversification
5.2. Post-Hedging Diversification of Risks
5.3. Summary of Results for Extensions
6. Conclusions
Funding
Acknowledgments
Conflicts of Interest
Appendix A. Optimal Hedging
Appendix B. Robustness
Appendix B.1. Comparing with Futures as Hedge
Sov Debt Crisis | Recovery | |||||
Hedge = | BUND | BTP | BUND+BTP | BUND | BTP | BUND+BTP |
AT(i) | −28 | 7 | −27 | −17 | −3 | −19 |
AT(ii) | −26 | 13 | −24 | −23 | −7 | −29 |
BE(i) | −1 | −11 | −19 | −10 | −6 | −16 |
BE(ii) | 10 | 2 | −12 | −16 | −5 | −22 |
DE(i) | −33 | 3 | −33 | −36 | −3 | −35 |
DE(ii) | −32 | 6 | −32 | −44 | −4 | −44 |
ES(i) | 2 | −36 | −33 | −2 | −24 | −23 |
ES(ii) | −2 | −33 | −35 | −4 | −26 | −26 |
FI(i) | −34 | 5 | −33 | −32 | −3 | −32 |
FI(ii) | −38 | 0 | −38 | −41 | −7 | −44 |
FR(i) | −22 | 6 | −21 | −16 | −4 | −19 |
FR(ii) | −18 | 12 | −22 | −20 | −8 | −27 |
GR(i) | 3 | 13 | 17 | 0 | 0 | 0 |
GR(ii) | 3 | 18 | 19 | 3 | 0 | 2 |
IE(i) | 0 | −5 | −6 | −1 | 0 | −1 |
IE(ii) | −4 | −2 | −5 | −4 | −1 | −3 |
IT(i) | 3 | −52 | −49 | −3 | −46 | −45 |
IT(ii) | 7 | −57 | −59 | −5 | −59 | −58 |
NL(i) | −33 | 5 | −32 | −29 | −2 | −29 |
NL(ii) | −29 | 3 | −31 | −37 | −3 | −38 |
PT(i) | 0 | −4 | −5 | 0 | −3 | −2 |
PT(ii) | 3 | −8 | −5 | 1 | −5 | −6 |
Appendix B.2. Hedge Effectiveness at Other Maturities
Pre-Crisis | Sov Debt Crisis | Recovery | |||||||
Term = | 10 Year | 5 Year | 2 Year | 10 Year | 5 Year | 2 Year | 10 Year | 5 Year | 2 Year |
AT(i) | −72 | −65 | −47 | −26 | −29 | −23 | −49 | −44 | −24 |
AT(ii) | −84 | −80 | −58 | −41 | −40 | −30 | −56 | −51 | −24 |
BE(i) | −77 | −67 | −56 | −20 | −23 | −15 | −52 | −35 | −15 |
BE(ii) | −83 | −81 | −76 | −29 | −26 | −20 | −57 | −45 | −10 |
DE(i) | −87 | −85 | −75 | −71 | −69 | −48 | −75 | −72 | −68 |
DE(ii) | −89 | −88 | −82 | −73 | −69 | −55 | −74 | −73 | −67 |
ES(i) | −69 | −67 | −62 | −28 | −44 | −42 | −43 | −50 | −43 |
ES(ii) | −75 | −80 | −77 | −35 | −38 | −36 | −43 | −48 | −37 |
FI(i) | −76 | −55 | −26 | −47 | −45 | −20 | −55 | −41 | −27 |
FI(ii) | −84 | −80 | −30 | −55 | −56 | −26 | −62 | −56 | −24 |
FR(i) | −83 | −81 | −75 | −31 | −33 | −29 | −59 | −49 | −31 |
FR(ii) | −88 | −86 | −82 | −38 | −38 | −35 | −61 | −52 | −27 |
GR(i) | −55 | −45 | −34 | −17 | 0 | 1 | −8 | ||
GR(ii) | −67 | −60 | −61 | 23 | 31 | 42 | 12 | ||
IE(i) | −52 | −40 | −17 | 1 | −13 | −27 | −14 | ||
IE(ii) | −72 | −40 | −27 | −6 | −10 | −35 | −19 | ||
IT(i) | −72 | −64 | −59 | −37 | −59 | −62 | −53 | −54 | −60 |
IT(ii) | −77 | −70 | −73 | −44 | −51 | −61 | −54 | −55 | −57 |
NL(i) | −81 | −71 | −54 | −43 | −42 | −25 | −56 | −47 | −39 |
NL(ii) | −86 | −84 | −72 | −51 | −53 | −42 | −65 | −57 | −36 |
PT(i) | −67 | −59 | −58 | 0 | −9 | −17 | −21 | −13 | −8 |
PT(ii) | −77 | −76 | −69 | −9 | −5 | −3 | −26 | −11 | 1 |
Avg(i) | −72 | −64 | −51 | −29 | −33 | −28 | −45 | −42 | −35 |
Avg(ii) | −80 | −75 | −64 | −33 | −32 | −27 | −47 | −47 | −31 |
Appendix B.3. Hedge Effectiveness under Higher Incidence of Extreme Losses
Pre-Crisis | Sov Debt Crisis | Recovery | ||||
Gaussian | T-Dist | Gaussian | T-Dist | Gaussian | T-Dist | |
AT(i) | −72 | −72 | −26 | −24 | −49 | −46 |
AT(ii) | −84 | −83 | −41 | −38 | −56 | −52 |
BE(i) | −77 | −77 | −20 | −19 | −52 | −49 |
BE(ii) | −83 | −82 | −29 | −26 | −57 | −54 |
DE(i) | −87 | −81 | −71 | −45 | −75 | −56 |
DE(ii) | −89 | −83 | −73 | −48 | −74 | −53 |
ES(i) | −69 | −68 | −28 | −34 | −43 | −40 |
ES(ii) | −75 | −76 | −35 | −38 | −43 | −40 |
FI(i) | −76 | −75 | −47 | −38 | −55 | −48 |
FI(ii) | −84 | −83 | −55 | −44 | −62 | −55 |
FR(i) | −83 | −84 | −31 | −26 | −59 | −57 |
FR(ii) | −88 | −88 | −38 | −44 | −61 | −59 |
GR(i) | −55 | −51 | −17 | −17 | −8 | 0 |
GR(ii) | −67 | −63 | 23 | 29 | 12 | 27 |
IE(i) | −52 | −50 | 1 | 0 | −27 | −26 |
IE(ii) | −72 | −73 | −6 | −9 | −35 | −34 |
IT(i) | −72 | −70 | −37 | −40 | −53 | −51 |
IT(ii) | −77 | −71 | −44 | −40 | −54 | −55 |
NL(i) | −81 | −81 | −43 | −37 | −56 | −51 |
NL(ii) | −86 | −87 | −51 | −46 | −65 | −57 |
PT(i) | −67 | −65 | 0 | 2 | −21 | −18 |
PT(ii) | −77 | −76 | −9 | −14 | −26 | −21 |
Avg(i) | −72 | −70 | −29 | −25 | −45 | −40 |
Avg(ii) | −80 | −79 | −33 | −29 | −47 | −41 |
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1. | A wider range of potential effects are considered in the report by the ESRB High-Level Task Force on Safe Assets (2018). |
2. | Gao et al. (2017) describe how, in that market, dealers typically hedge inventory risk in their Specific-Pool exposures with offsetting TBA trades and they show that impediments to hedging can reduce such liquidity. More interestingly, they conclude that the presence of TBA markets has very widespread beneficial effects on liquidity significantly beyond the mortgage pools that are cheapest to deliver. This is also traced to the ability to hedge inventory holding risk. |
3. | In a related paper, the acquisition of benchmark status in pre-crisis European sovereign bond markets is examined in Dunne et al. (2007). Benchmarks tend to become liquid as they are the location for discovery of the systematic component of the risk premium (in this case, it is envisaged that the different tranches of SBBS would be benchmarks for credit risks within different categories of the market). |
4. | Whether these bounds are sufficient to improve on current trading costs is moot. Even if the costs of hedging with SBBS were to exceed current trading costs in national markets, their use in this way would still be relevant in minimising the extent of any deterioration in trading costs due directly to reductions in the free float as a result of the securitisation. |
5. | This also relies, for simplicity, on the assumption that there is symmetry in the positioning of spreads relative to the underlying value. If not, then the proposition that follows applies on average across many trades. |
6. | It may also be supposed that this benign outcome would be compromised if the SBBS has a difficult-to-forecast correlation with the bond (i.e., if out of sample hedge ratios turn out to be less efficient than they could have been). This is really a type of operational risk and (assuming forecasts are as efficient as possible ex ante) this also gives rise to mostly idiosyncratic and diversifiable risks. |
7. | Bessler et al. (2016) point out that several futures markets for individual sovereign bonds existed pre-EMU and that the alignment of yields during the years of the Great Moderation was largely responsible for the disappearance of all but the German Bund futures. The Great Financial Crisis and the Sovereign Debt Crisis in Europe ultimately led to the reintroduction of futures on Italian BTPs and French OATs. Futures on Spanish Bonos only reappeared in 2015. Naik and Yadav (2003) examine the use of futures to hedge interest rate risk (undesirable duration) in sovereign bond portfolios of dealers and they find support for the propositions about hedging behaviour by Froot and Stein (1998). |
8. | For example, Naik and Yadav (2003) strongly reject the notion that dealers benefit from their information about orderflow even in the relatively concentrated UK Gilts market. |
9. | The implied risk premium (i.e., yield above the risk-free rate) reflects the risk aversion of the representative market investor on any given day and, hence, may exceed the expected loss anticipated by a risk-neutral investor. This degree of risk aversion enters the simulation and is consequently also reflected consistently in the resulting estimated yields of senior, mezzanine and junior SBBS. |
10. | A similar analysis employing dynamic conditional correlation methods, compiling hedge ratios using conditional variances and covariances in line with the relations presented in Appendix A, did not in fact lead to significantly different hedge effectiveness ratios. In addition, the combined use of the methods of Gibson et al. (2017) and a stochastic volatility modelling approach designed to address the presence of isolated outliers, due to Chan and Grant (2016), also failed to change the conclusions drawn from the more straightforward application of a rolling linear regression approach. These alternative methods may however lead to improvements when used at higher frequency with regular updating. Extending the analysis to such a frequency is beyond the scope or needs of the present study. |
11. | The cases of Austria (AT) and Finland (FI) are not shown above but are quite similar to the case of NL. |
12. | The weights used in the analysis are related to the size of the individual sovereign float relative to that of the total of 11 sovereigns in the euro area market (weights are provided in the notes for Table 4). |
13. | It has been shown by Baranova et al. (2017) that recent tightening of capital and leverage requirements of financial intermediaries has damaged liquidity provision during calm markets’ conditions, but it has helped to protect liquidity during crises’ circumstances. Getting the balance right is therefore crucial. |
1 SBBS | 2-SBBS | 3-SBBS | |||||
Hedge = | Snr | Mezz | Jnr | Snr-Mezz | Snr-Jnr | Mezz-Jnr | Snr-Mezz-Jnr |
AT(i) | −62 | −61 | −35 | −67 | −70 | −50 | −72 |
AT(ii) | −73 | −72 | −35 | −77 | −82 | −57 | −84 |
BE(i) | −65 | −63 | −36 | −72 | −75 | −52 | −77 |
BE(ii) | −71 | −70 | −37 | −76 | −80 | −58 | −83 |
DE(i) | −79 | −78 | −32 | −84 | −84 | −46 | −87 |
DE(ii) | −85 | −81 | −31 | −86 | −88 | −49 | −89 |
ES(i) | −55 | −55 | −36 | −62 | −66 | −53 | −69 |
ES(ii) | −62 | −61 | −36 | −69 | −73 | −58 | −75 |
FI(i) | −70 | −69 | −35 | −72 | −75 | −46 | −76 |
FI(ii) | −79 | −77 | −36 | −81 | −84 | −53 | −84 |
FR(i) | −72 | −71 | −37 | −78 | −80 | −53 | −83 |
FR(ii) | −76 | −75 | −37 | −81 | −84 | −59 | −88 |
GR(i) | −36 | −33 | −27 | −46 | −51 | −49 | −55 |
GR(ii) | −46 | −44 | −33 | −60 | −60 | −58 | −67 |
IE(i) | −42 | −40 | −26 | −47 | −51 | −39 | −52 |
IE(ii) | −66 | −62 | −33 | −70 | −72 | −52 | −72 |
IT(i) | −50 | −47 | −35 | −63 | −65 | −59 | −72 |
IT(ii) | −56 | −50 | −37 | −69 | −70 | −64 | −77 |
NL(i) | −69 | −68 | −37 | −75 | −78 | −54 | −81 |
NL(ii) | −77 | −75 | −36 | −80 | −83 | −58 | −86 |
PT(i) | −50 | −48 | −34 | −59 | −63 | −54 | −67 |
PT(ii) | −62 | −60 | −38 | −69 | −73 | −61 | −77 |
1 SBBS | 2-SBBS | 3-SBBS | |||||
Hedge = | Snr | Mezz | Jnr | Snr-Mezz | Snr-Jnr | Mezz-Jnr | Snr-Mezz-Jnr |
AT(i) | −24 | −11 | 0 | −32 | −16 | 4 | −26 |
AT(ii) | −32 | −19 | −2 | −41 | −39 | −5 | −41 |
BE(i) | −3 | −4 | −2 | −27 | 10 | −16 | −20 |
BE(ii) | −2 | −2 | 0 | −27 | −10 | −17 | −29 |
DE(i) | −68 | 0 | 7 | −72 | −67 | 4 | −71 |
DE(ii) | −69 | 4 | 5 | −73 | −69 | −5 | −73 |
ES(i) | 1 | 10 | 1 | −33 | 10 | −31 | −28 |
ES(ii) | −3 | 15 | 5 | −29 | −13 | −34 | −35 |
FI(i) | −52 | −7 | 3 | −52 | −49 | 6 | −47 |
FI(ii) | −54 | −4 | 2 | −54 | −54 | 4 | −55 |
FR(i) | −23 | −12 | 0 | −35 | −15 | 0 | −31 |
FR(ii) | −30 | −12 | 2 | −38 | −32 | 2 | −38 |
GR(i) | 0 | 1 | 0 | 0 | −15 | −15 | −17 |
GR(ii) | −4 | 13 | 11 | 2 | 26 | 28 | 23 |
IE(i) | 2 | 7 | 2 | −3 | 1 | −2 | 1 |
IE(ii) | −1 | 6 | 3 | −5 | −8 | −7 | −6 |
IT(i) | 0 | 10 | 1 | −44 | 18 | −39 | −37 |
IT(ii) | 2 | 13 | 3 | −40 | −9 | −43 | −44 |
NL(i) | −49 | −9 | 2 | −48 | −46 | 7 | −43 |
NL(ii) | −53 | −6 | 5 | −52 | −52 | 3 | −51 |
PT(i) | 1 | 5 | 1 | −1 | 1 | −2 | 0 |
PT(ii) | 1 | 2 | 1 | −5 | −10 | −8 | −9 |
1 SBBS | 2-SBBS | 3-SBBS | |||||
Hedge = | Snr | Mezz | Jnr | Snr-Mezz | Snr-Jnr | Mezz-Jnr | Snr-Mezz-Jnr |
AT(i) | −45 | −22 | 0 | −47 | −49 | −10 | −49 |
AT(ii) | −51 | −25 | 0 | −53 | −57 | −14 | −56 |
BE(i) | −44 | −26 | −2 | −48 | −53 | −13 | −52 |
BE(ii) | −50 | −28 | −3 | −53 | −57 | −15 | −57 |
DE(i) | −73 | −13 | 4 | −74 | −73 | −8 | −75 |
DE(ii) | −72 | −10 | 4 | −73 | −73 | −7 | −74 |
ES(i) | −2 | 2 | −3 | −32 | −26 | −42 | −43 |
ES(ii) | −4 | −6 | −4 | −29 | −28 | −41 | −43 |
FI(i) | −52 | −16 | 1 | −53 | −55 | −9 | −55 |
FI(ii) | −59 | −18 | 1 | −60 | −62 | −11 | −62 |
FR(i) | −50 | −27 | −2 | −55 | −58 | −15 | −59 |
FR(ii) | −54 | −28 | −2 | −56 | −61 | −16 | −61 |
GR(i) | 0 | 7 | 7 | −8 | −8 | 2 | −8 |
GR(ii) | 5 | 6 | 8 | 3 | 11 | 17 | 12 |
IE(i) | −10 | −11 | −3 | −21 | −22 | −19 | −27 |
IE(ii) | −14 | −17 | −5 | −29 | −28 | −23 | −35 |
IT(i) | −3 | 1 | −4 | −41 | −28 | −50 | −53 |
IT(ii) | −7 | −5 | −4 | −41 | −34 | −52 | −54 |
NL(i) | −53 | −18 | 1 | −54 | −56 | −9 | −56 |
NL(ii) | −60 | −18 | 0 | −61 | −64 | −11 | −65 |
PT(i) | 0 | 2 | 0 | −13 | −15 | −21 | −21 |
PT(ii) | −1 | 2 | 0 | −13 | −17 | −25 | −26 |
Pre-Crisis | Sov Debt Crisis | Recovery | ||||
Weighting = | Equal | Size | Equal | Size | Equal | Size |
10-Year | ||||||
EA(Hedged)/EA (i) | −68 | −71 | 0 | −3 | −12 | −24 |
EA(Hedged)/EA (ii) | −73 | −74 | −4 | −7 | −18 | −31 |
EA(Hedged)/DE (i) | −71 | −73 | 8 | −1 | −4 | −24 |
EA(Hedged)/DE (ii) | −76 | −76 | −2 | −14 | −11 | −29 |
5-Year | ||||||
EA(Hedged)/EA (i) | −47 | −43 | 1 | −1 | −17 | −15 |
EA(Hedged)/EA (ii) | −46 | −44 | 0 | 1 | −20 | −21 |
EA(Hedged)/DE (i) | −50 | −46 | 52 | 25 | −21 | −3 |
EA(Hedged)/DE (ii) | −50 | −46 | 34 | 12 | −27 | −10 |
2-Year | ||||||
EA(Hedged)/EA (i) | −62 | −64 | 1 | −1 | −5 | −5 |
EA(Hedged)/EA (ii) | −69 | −72 | 1 | 4 | −7 | −10 |
EA(Hedged)/DE (i) | −70 | −67 | 252 | 81 | 21 | 47 |
EA(Hedged)/DE (ii) | −76 | −74 | 186 | 64 | 15 | 38 |
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Dunne, P.G. Positive Liquidity Spillovers from Sovereign Bond-Backed Securities. J. Risk Financial Manag. 2019, 12, 58. https://doi.org/10.3390/jrfm12020058
Dunne PG. Positive Liquidity Spillovers from Sovereign Bond-Backed Securities. Journal of Risk and Financial Management. 2019; 12(2):58. https://doi.org/10.3390/jrfm12020058
Chicago/Turabian StyleDunne, Peter G. 2019. "Positive Liquidity Spillovers from Sovereign Bond-Backed Securities" Journal of Risk and Financial Management 12, no. 2: 58. https://doi.org/10.3390/jrfm12020058
APA StyleDunne, P. G. (2019). Positive Liquidity Spillovers from Sovereign Bond-Backed Securities. Journal of Risk and Financial Management, 12(2), 58. https://doi.org/10.3390/jrfm12020058