Liquidity Externalities and Information Spillover between the Equity and Corporate Bond Markets: An Empirical Study

Abstract

Information spillover and liquidity externality across securities is of practical importance to both practitioners and policy makers. We empirically examine how information spillover facilitates liquidity externalities between the equity and corporate bond markets. An event study was conducted by comparing the change of liquidity of stocks whose corporate bonds are TRACE-eligible with that of non-TRACE-eligible control stocks around the initiation of the TRACE system. It is found that the TRACE initiation significantly reduced the illiquidity of corresponding common stocks, which provide empirical evidence supporting the hypothesis of cross-market liquidity externalities.