UiS Working Papers in Economics and Finance,
University of Stavanger

Abstract: This paper studies the drivers of primary dealers’repo activity and the e¤ect of repo market frictions on bond market liquidity. It separates the two tiers of the bond market, the electronic limit order book (LOB) and the over-the-counter (OTC) market. The results, based on dealer-specific repo quantities and cash market trades in Norwegian government bonds, show that the passive order flow in the LOB is an important driver of repo activity. Liquidity in both tiers deteriorate with higher repo specialness, which represents the cost of "borrowing" bonds. This suggests that primary dealers enter the repo market to borrow bonds when their inventories are depleted via executed ask limit orders. Intermediaries in electronic bond markets thus face an additional risk related to the level of repo specialness.

Keywords: Electronic bond trading; primary dealers; repo market frictions; safe asset scarcity.

JEL-codes: G12; G14; G15; G20

Language: English

35 pages, February 10, 2023

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