Economic Letter: Liquidity analysis on Bond and Money Market Funds

An Economic Letter by Naoise Metadjer and Kitty Moloney considers the importance of the definition of liquidity for stress tests on Investment Funds (IFs) and Money Market Funds (MMFs) and presents a prototype methodology for liquidity monitoring based on maturity, sector and credit ratings of securities held by a number of Irish-domiciled funds.

The key findings are:

• The High Quality Liquid Asset (HQLA) framework initiated under Basel III is appropriate for MMFs and sovereign bond funds who invest primarily in advanced economies, but less appropriate for more complex funds such as those who primarily invest in less developed (emerging) markets or lower credit quality (high yield) assets.
• Liquidity indicators based on credit ratings and sector do not take into account market depth, trading volume, price impact or transaction costs; which are common elements of liquidity metrics in literature.
• Further research is required into more appropriate measures of portfolio liquidity, particularly for funds focusing on sub-investment grade and financial sector debt securities, and into the development of methodologies which take a more holistic view of the risks associated with the funds industry to capture interactions which could inform stress tests and systemic risk analyses.

The views presented in Economic Letters are those of the authors alone and do not necessarily represent the official views of the Central Bank of Ireland.

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