SMU SOE Seminar Series (April 22, 2026): A Macroeconomic Model with Bond Market Liquidity

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ABSTRACT

I study the effects of corporate bond market liquidity on the macroeconomy. I develop a dynamic general equilibrium model in which firms roll over long-term bonds that are traded in over-the-counter secondary markets featuring search and bargaining frictions. Worsened bond market liquidity lowers bond prices and increases firm default probability through the rollover channel. Firms hire labor and borrow working capital loans to pay wages upfront. A higher default probability leads to higher interest rates on working capital loans and thus higher labor costs, and consequently, employment drops. By calibrating the model to match the observed increase in bid-ask spreads in the US corporate bond market, I show that disruptions in bond market liquidity could explain 36% of the labor drop during the Great Recession. The paper also provides a structural estimate of the real effects of the Fed's interventions in the corporate bond market during the COVID-19 crisis. By improving bond market liquidity, the Fed's interventions avoided a 4.3 percentage point drop in employment.