The Effects of the Volcker Rule on Corporate Bond Trading: Evidence from the Underwriting Exemption
Published: August 6, 2019
This paper examines the impact of the Volcker rule, which bans proprietary trading by commercial banks and their affiliates, with some exceptions. It finds evidence that the rule has increased the cost of liquidity provided by firms it covers, but not decreased the firms’ exposure to liquidity risk. It also finds that the rule has decreased the market share of covered firms. Customers appear to be trading more with non-bank dealers, who are exempt from the Volcker rule but also cannot borrow at the Federal Reserve’s discount window. (Working Paper no. 19-02)
Using a novel within-dealer, within-security identiﬁcation strategy, we examine intended and unintended eﬀects of the Volcker rule on covered ﬁrms’ corporate bond trading using dealer-identiﬁed regulatory data. We use the underwriting exemption to isolate the Volcker rule’s eﬀects separate from other post-crisis changes in bank regulation and broader trends in market liquidity. We ﬁnd no evidence of the rule’s intended reduction in the riskiness of covered ﬁrms’ trading in corporate bonds. We ﬁnd signiﬁcant adverse liquidity eﬀects on covered ﬁrms’ corporate bond trading with 20-45 basis points higher costs for customers even for roundtrip trades of shorter duration. These eﬀects do not appear to be transitional. The Volcker rule appears to have increased the cost of the liquidity provided by covered ﬁrms and has not decreased the liquidity risk exposure of covered ﬁrms. Finally, the Volcker rule has decreased the market share of covered ﬁrms. Customers appear to be trading more with non-bank dealers, who are exempt from the Volcker rule but also lack access to emergency liquidity support at the Fed’s discount window.