The Value of Introducing Structural Reform to Improve Bond Market Liquidity : Experience from the U.K. Gilt Market

The importance of maintaining sufficient liquidity in financial markets is emphasised strongly in the academic literature. During the 1990s the United Kingdom monetary authorities introduced a number of structural reforms in the government bond market, aimed at improving secondary market liquidity. In this paper we examine the impact of the reforms by attempting to ascertain if liquidity levels improved in the post-reform period. We estimate the change in liquidity levels through the use of a proxy measure of liquidity, namely the benchmark bond theoretical versus market yield error. We examine the determinants of the proxy measure of market liquidity, and estimate which of the explanatory variables carries the greatest weight in influencing liquidity levels. We identify those factors that contributed most to maintaining secondary market liquidity and thereby draw conclusions of potential value to sovereign bond market monetary authorities