Amber Anand, Chotibhak Jotikasthira, Kumar Venkataraman
Publication year: 2017

This study presents new evidence on buy-side institutions as a channel of liquidity supply in the corporate bond market. Using bond transactions data, we aggregate the inventory positions of bond dealers, and identify inventory cycles. We classify a bond fund’s trading style as liquidity supplying (demanding) if the changes in bond holdings exhibit a propensity to absorb (further strain) the aggregate dealer positions. Between 2003 and 2014, bond funds on average tend to demand liquidity; however, trading styles vary across bond funds and are persistent over time. Higher flexibility in portfolio holdings is associated with a liquidity supplying trading style. A liquidity supplying trading style earns higher future fund returns after controlling for portfolio attributes and factor risk exposures. These results suggest that trading style contains useful information for investors in selecting bond funds and that bond market liquidity can be enhanced by developing platforms that facilitate participation by buy-side institutions.