The Liquidity of Swedish Covered Bonds compared to Swedish Government Bonds

Abstract: In the Swedish context covered bonds are a young financial development that quickly became crucial for the financial stability of the country. The intended goal of this paper is to compare the liquidity of this type of debt to the liquidity of Swedish government bonds, which generally is considered a very safe asset. For this purpose we test the price impact, as well as the liquidity risk of both markets. Overall, we conclude that the liquidity of short term covered bonds is not very inferior compared to that of short term government bonds under normal conditions, however in stress periods, such as the financial crisis in the autumn of 2008, the liquidity of short term government bonds are higher. We also find that short term bonds are more liquid than long term bonds in both markets and long term covered bonds demonstrate higher liquidity than long term government bonds over time. Finally, we observe that the liquidity risk of all markets except for short term government bonds rises during the crisis and later returns to its pre-crisis levels. We also find, the quite counterintuitive result, that larger trades do not have a larger price impact. We compare most of our findings to those of Dick-Nielsen et al (2012) for Denmark in order to get insight of the relative performance of the Swedish covered bond market to the Danish one.