##ocation. similarly, dealers apparently are unwilling to provide the funding and the balance sheet capacity necessary for their leveraged clients to arbitrage away this dislocation. the degree to which this shift in the yield spread between treasury and interest rate swap yields is due to the differential capital requirements imposed on cash versus derivative instruments warrants more investigation. just as market and funding liquidity are interlinked, so are funding liquidity and capital requirements. all else equal, stronger capital requirements reduce firms ’ vulnerability to runs. this suggests that funding liquidity risk can be addressed in many different ways. first, capital requirements can be bolstered to reduce the risk that a firm will become insolvent in particularly bad states of the world. second, improved reporting and transparency can reduce the degree of uncertainty about whether a firm is solvent, thus reducing the risk that brunnermeier and pedersen ( 2009 ) “ market liquidity and funding liquidity ” review of financial studies 22 pp. 2201 – 2238 provide a theory that features strong correlation between market and funding liquidity during crises. hu, pan, wang ( 2013 ) “ noise as information for illiquidity ” journal of finance 68 ( 6 ), pp. 2341 – 2382 provide further evidence on the relationship between yield curve fitting errors and alternative funding liquidity metrics. bis central bankers ’ speeches investors might wrongly perceive that a firm is insolvent, when, in fact, it still has adequate capital. third, liquidity requirements can be increased to reduce the risk that the firm will have to engage in a fire sale of assets that might deplete its capital. also, a liquidity buffer gives the firm ’ s management time to respond to bad events without having to resort immediately to selling assets. fourth, a lender - of - last - resort can provide a liquidity backstop that makes funding liquidity more resilient. consider the case when a counterparty is uncertain about how other potential lenders view a firm ’ s solvency. if there is no lender - oflast - resort backstop, this may cause firms to be unwilling to lend, not because they perceive the counterparty as insolvent, but, instead, because they are worried about what others think. that is, i may be unwilling to lend to you, not because i perceive you as insolvent, but because i am uncertain about how others view your solvency. if i do lend and others

trace data show what trades have taken place, not what trades have potentially been foregone because of any possible diminution of market liquidity. gaining a better understanding of this phenomenon is being actively researched by my staff. in contrast to the market liquidity metrics such as bid - ask spreads, indirect evidence on market liquidity suggests that there has been a decline. asset managers report that large blocks of securities are now harder to buy and sell without generating significant movements in prices. also, average trade sizes have decreased ( exhibit 4 ) and there is evidence of a growing bifurcation in the corporate bond market, with greater activity and liquidity in those bonds that were issued more recently, larger in size or brought to market by larger issuers. also, capital and liquidity requirements for the largest securities dealers – which have been raised significantly since the financial crisis – might have adversely impacted market liquidity. these regulatory changes likely have affected the profitability of dealer intermediation activities and consequently the provision of market liquidity. for the treasury market, the most important change in regulatory requirements appears to be the supplementary leverage ratio ( slr ). the slr limits the leverage of dealer balance sheets. in the slr, all assets are treated the same in terms of required regulatory capital. consequently, the slr is much tougher on low - risk assets as compared to the risk - based capital measures that it complements. this makes the economics of repo - financing much less attractive. not surprisingly, we observe significant declines in the quantity of repo financing by dealers ( exhibit 5 ). for the corporate bond market, the most relevant regulatory changes appear to be the increase in the basel risk - weighted capital ratio, the comprehensive capital and analysis review ( ccar ) stress tests and the volcker rule – which prohibits proprietary trading for a number of asset classes such as corporate bonds, albeit not u. s. treasuries. we do observe significant declines in recent years in securities dealers ’ holdings of corporate bonds ( exhibit 6 ). it would be surprising if these declines in repo and corporate bond holdings did not have some consequence for market liquidity. however, we do not observe marked declines in dealer holdings of treasuries, even as overall dealer assets have stagnated ( exhibit 7 ). the see adrian, fleming, stackman, vogt ( 2015 ) has u. s. treasury market liquidity deteriorated?, liberty street economics blog, august 17