Focusing on downgrades as stress events that drive the selling of corporate bonds, we show that the illiquidity of stressed bonds has increased after the Volcker Rule. Dealers regulated by the rule have curtailed their market-making activities and non-Volcker-affected dealers have not offset the decreased activities of Volcker-affected dealers. Furthermore, even Volcker-affected dealers that are not constrained by Basel III and Comprehensive Capital Analysis and Review regulations change their behavior, inconsistent with the effects being driven by these other regulations. Because Volcker-affected dealers have been the main liquidity providers, bonds have become less liquid during times of stress due to the Volcker Rule.

This paper investigates execution quality issues in corporate bond trading. Using an extensive sample of bond trades by insurance companies, we find that an insurance company entering a trade of similar size and on the same side for the same bond on the same day with the same dealer will receive a better price if the insurance company is a more active trader than if it is a less active trader. Trading with the dominant dealer or underwriter worsens these differentials, while greater transparency and smaller trading networks lessens these effects. Our results provide strong evidence that execution quality differences remain pervasive in corporate bond trading.