Notes on Bonds: Illiquidity Feedback During the Financial Crisis.

We trace the evolution of extreme illiquidity discounts among Treasury securities during the financial crisis, when bond prices fell more than 6% below more liquid but otherwise identical notes. Using high-resolution data on market quality and trader identities and characteristics, we find that the discounts amplify through feedback loops, where cheaper, less-liquid securities flow to longer-horizon investors, thereby increasing their illiquidity and thus their appeal to these investors. The effect of the widened liquidity gap on transactions costs is further amplified by a surge in the price liquidity providers charge for access to their balance sheets in the crisis. Received September 28, 2016; editorial decision January 2, 2018 by Editor Philip Strahan. Authors have furnished an Internet Appendix , which is available on the Oxford University Press Web site next to the link to the final published paper online. [ABSTRACT FROM AUTHOR]