The Volcker Rule and corporate bond market making in times of stress

Focusing on downgrades as stress events that drive the selling of corporate bonds, we show that the illiquidity of stressed bonds has increased after the Volcker Rule. Dealers regulated by the rule have curtailed their market-making activities and non-Volcker-affected dealers have not offset the decreased activities of Volcker-affected dealers. Furthermore, even Volcker-affected dealers that are not constrained by Basel III and Comprehensive Capital Analysis and Review regulations change their behavior, inconsistent with the effects being driven by these other regulations. Because Volcker-affected dealers have been the main liquidity providers, bonds have become less liquid during times of stress due to the Volcker Rule.