Outages in Sovereign Bond Markets
In short
- When Eurex, the euro area’s dominant futures exchange, goes down, trading volumes in the cash market for sovereign bonds drop by over 70%, and liquidity falls by a similar amount.
- German government bonds (Bunds) trade far from fundamental values during Eurex outages: the root mean squared pricing error roughly quadruples, exceeding its peak during the Covid-19 turmoil in March 2020.
- Two mechanisms drive this: without Bund futures, dealers lose their hedging instrument and intermediate less, and clients lose their benchmark price and face wider information asymmetries.
- Outages on the cash market, in contrast, merely reduce futures trading: price formation and liquidity provision run one way, from futures to cash.
Abstract
We exploit outages in sovereign bond markets as natural experiments. When the euro area futures market goes down, trading volumes on the cash market decline, liquidity evaporates, and prices deviate from fundamental values. Micro-level evidence reveals two mechanisms: the loss of a hedging instrument reduces dealers’ intermediation capacity, and the missing benchmark price widens information asymmetries for clients. Outages on the cash market, in contrast, merely reduce futures trading activity, implying one-way price formation and liquidity provision. Our findings highlight the trade-offs of market centralization, support cross-asset learning over symmetric arbitrage models, and demonstrate how intermediaries impose limits to arbitrage.