Liquidity Matters
http://www.morningstar.co.uk/uk/news/154004/is-the-corporate-bond-bubble-about-to-burst.aspx
As US Treasury yields are up, there is a fear among investors that bubbles in corporate bonds would burst soon. This could be partly due to a surprise victory of Donald Trump in US President election, which gave investors impressions there will be inflationary effects because of his promise of huge nation-wide infrastructural projects. In past recent months, there has been increase in Bonds and Treasuries reflecting improving economic data. If yields continue to rise, experts say that there will be a sell-off in corporate bonds as already factors that kept yields at low level started to reverse as seen in rising wage and nominal GDP. For past few years, low yields have made investors to look for other options such as corporate bonds, but those investors fell into corporate debts or fundamentals of the firms issuing debts. Experts warn these factors might lead a bigger sell-off in corporate bonds.
The problem of trade-off between Treasuries and corporate bonds is liquidity. Since Treasuries are provided at fixed rate over years, its liquidity is very low compared to corporate bonds which can be liquefied almost at constant time. Also recent run of property fund suspensions in UK suggests that how quickly that problem became shows there is cascade effect of people’s fear and lost confidence in corporate bonds. This sell-off can cause fund managers hard time to deal with investors daily. Since everyone is heading for one door, liquidity of this move can be hardly met at the same time. With this phenomenon, experts advise investors to consider liquidity of their assets because only the most liquid financial assets can be sold at the worst moments.
As learned in class, cascade effect can happen in two situations where there are information cascade and benefit cascade. In this sell-off situation described above, this would be information cascade because people are judging based on other people’s previous choices, and there is cascade towards buying government bonds which apparently affect them badly if they all do it. For resolution, we should always value private information from trustworthy people or have more information before we make decisions. Herding mostly results in good, but sometimes very bad.