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What drives the liquidity of sovereign bonds when markets are under stress? An assessment of the new Basel 3 rules on bank liquid assets
Institution:1. Università Cattolica, largo Gemelli 1, 20123 Milano, Italy;2. Bocconi University, via Roentgen 1, 20136 Milano, Italy;1. Bank of Greece, Greece;2. University of Leicester, United Kingdom; Bank of Greece, Greece;3. Bank of Greece, 21 E Venizelos Ave, Athens 10250, Greece; University of Leicester, United Kingdom;1. Office of Financial Research, 717 14th Street, NW, Washington, DC 20005, USA;2. Media and Graphic Interdisciplinary Centre, University of British Columbia, Forest Sciences Centre Building, FSC 3640 – 2424 Main Mall, Vancouver, BC, Canada V6T 1Z4;3. Old Road Campus Research Building, Old Road Campus, University of Oxford, Roosevelt Drive, Oxford OX3 7DQ, UK;4. Human-Computer Interaction and Head Interaction Design Centre, School of Science and Technology, Middlesex University London, The Burroughs, Hendon, London NW4 4BT, UK;1. Department of Economics, Wilfrid Laurier University, Canada;2. Centre for Applied Macroeconomic Analysis (CAMA), Australia;3. Deutsche Bundesbank, Frankfurt am Main, Germany;4. Department of Economics, Westfälische Wilhelms-Universität Münster, Am Stadtgraben 9, 48143 Münster, Germany;1. Imperial College Business School, United Kingdom;2. Accounting Department, Kozminski University, Poland;3. Institute of Economics of the Polish Academy of Science (INE PAN), Poland;4. World Economy Research Institute, Warsaw School of Economics (SGH), Poland;5. VU University Amsterdam and Duisenberg School of Finance, The Netherlands;1. Department of Economics, City University London, Social Sciences Building, Northampton Square, London EC1V 0HB, UK;2. Department of Economics, City University London and Department d’Economia Aplicada, Universitat Autònoma de Barcelona, Edifici B Campus de la UAB, Cerdanyola del Vallès, 08193, Barcelona, Spain
Abstract:The new rules on bank liquidity set by the Basel Committee require banks to hold high-quality liquid assets (HQLAs) against future cash outflows in periods of market stress. Domestic government bonds are considered to be HQLAs. To assess the appropriateness of this rule, we investigate the liquidity of European government bonds in ordinary times and in periods of market turmoil. We find that the effect of adverse market conditions on liquidity strongly depends on individual bond’s characteristics. Our evidence argues for rules on HQLAs that should constrain the eligibility of government bonds depending on their characteristics (primarily, duration and rating).
Keywords:Liquidity risk  Liquidity coverage ratio  High-quality liquid assets (HQLAs)  Basel 3  Basel committee
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