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Liquidity in fixed income markets – risk indicators and EU evidence

Over the last few years, market analysts have pointed at an overall reduction of liquidity in fixed income markets. Market liquidity is important to ensure the efficient functioning of financial markets. Poor liquidity is likely to impose significant costs on investors and hence, ultimately on savers and the real economy. This paper provides a broad overview on different dimensions of liquidity in EU government bond markets and in EU corporate bond markets, covering the period from July 2006 to December 2016. Our findings show that, having deteriorated during the financial and sovereign debt crises, sovereign bond market liquidity has increased since then, potentially also due to the effects of supportive monetary policy in recent years. However, we find evidence of several episodes signaling deteriorating secondary market liquidity for corporate bonds, especially between 2014 and 2016. In the sovereign segment, market liquidity seems to be more abundant for bonds that have a benchmark status and issued in larger dimensions. In the corporate segment larger outstanding amounts are related to lower market illiquidity. In both segments, increased stress in financial markets is correlated with deterioration in market liquidity.