We examine the dynamics and the drivers of market liquidity during the financial crisis, using a unique volume-weighted spread measure. According to the literature we find that market liquidity is impaired when stock markets decline, implying a positive relation between market and liquidity risk. Moreover, this relationship is the stronger the deeper one digs into the order book. Even more interestingly, this paper sheds further light on so far puzzling features of market liquidity: liquidity commonality and flight-to-quality. We show that liquidity commonality varies over time, increases during market downturns, peaks at major crisis events and becomes weaker the deeper we look into the limit order book. Consistent with recent theoretical models that argue for a spiral effect between the financial sector’s funding liquidity and an asset’s market liquidity, we find that funding liquidity tightness induces an increase in liquidity commonality which then leads to market-wide liquidity dry-ups. Therefore our findings corroborate the view that market liquidity can be a driving force for financial contagion. Finally, we show that there is a positive relationship between credit risk and liquidity risk, i.e., there is a spread between liquidity costs of high and low credit quality stocks, and that in times of increased market uncertainty the impact of credit risk on liquidity risk intensifies. This corroborates the existence of a flight-to-quality or flight-to-liquidity phenomenon also on the stock markets.

We examine the dynamics and the drivers of market liquidity during the financial crisis, using a unique volume-weighted spread measure. According to the literature we find that market liquidity is impaired when stock markets decline, implying a positive relation between market and liquidity risk. Moreover, this relationship is the stronger the deeper one digs into the order book. Even more interestingly, this paper sheds further light on so far puzzling features of market liquidity: liquidity commonality and flight-to-quality. We show that liquidity commonality varies over time, increases during market downturns, peaks at major crisis events and becomes weaker the deeper we look into the limit order book. Consistent with recent theoretical models that argue for a spiral effect between the financial sector’s funding liquidity and an asset’s market liquidity, we find that funding liquidity tightness induces an increase in liquidity commonality which then leads to market-wide liquidity dry-ups. Therefore our findings corroborate the view that market liquidity can be a driving force for financial contagion. Finally, we show that there is a positive relationship between credit risk and liquidity risk, i.e., there is a spread between liquidity costs of high and low credit quality stocks, and that in times of increased market uncertainty the impact of credit risk on liquidity risk intensifies. This corroborates the existence of a flight-to-quality or flight-to-liquidity phenomenon also on the stock markets.

We examine the impact of the EU Banking Union on the information production of stress tests by exploiting the institutional shift in supervisory responsibility for significant banks to the European Central Bank (ECB) under the Single Supervisory Mechanism (SSM). We hypothesize that a centralized authority with both supervisory and financial stability mandates may reduce the informativeness of stress tests to mitigate negative spillovers, particularly potential threats to financial stability arising from disclosure. Our findings support this hypothesis, showing that the information production from stress tests declined following the introduction of the SSM. This reduction is primarily driven by weakly performing banks. We find no support for alternative explanations such as supervisory leniency, market learning, or the absence of an acute crisis.

In an attempt to match US bankruptcy law, many European countries have reformed their insolvency laws towards a regime that fosters corporate restructuring. This paper evaluates the implications of these reforms. Based on a staggered difference-in-differences analysis around eight insolvency reforms in 15 European countries, this paper finds a relative increase in the cost of debt by about 50 bps in countries with such a reform. The effect is more pronounced among firms being closer to default. As a result of increased cost of debt financing, firms cut investment, innovation, and employee pay. In addition, firms are also more likely to turn into zombies post-treatment. Overall, the results are consistent with the view that creditors may be negatively affected by insolvency law reforms oriented towards restructuring and, thus, demand higher risk premia. This, in turn, causes real effects in the corporate sector.