Funding Liquidity and Market Liquidity in Government Bonds

Using a comprehensive dataset of orders and trades in the Indian government bond market, this study presents new evidence on the effect of funding liquidity on market liquidity. We measure both price and quantity dimension of funding conditions. As expected, tightening along one dimension significantly reduces bond market liquidity when the other dimension is already tight. However, individually, price and quantity tightening often improve market liquidity considerably. This finding is robust to controlling for numerous potential confounding channels. Funding conditions can apparently have substantial effects on asset market liquidity, but not in a manner readily explained by extant theories.