Was the ECB’s PEPP Project Effective in Ending the COVID-Induced Crisis in the Bond Market?

This paper investigates the 2020 pandemic-induced financial crisis in the European corporate bond market and the ECB’s QE (PEPP) effectiveness in resolving it. By analyzing credit (Z-spread) and liquidity risks (scaled bid-ask spread), we find that the crisis raised Z-spreads of ineligible and eligible bonds by 10.7% and 8.4%, respectively. Moreover, the bid-ask spread of ineligible bonds rose by 16 basis points (bp) or 22.9%. In contrast, the spread of eligible bonds remained nearly unchanged – demonstrating QE provided liquidity for eligible corporate bonds. Ineligible bonds issued by covid-sensitive firms (covid firms) experienced a higher increase in credit and liquidity spreads than eligible bonds issued by covid firms or ineligible bonds issued by non-covid firms. The PEPP announcement mainly reduced the Z-spread of ineligible bonds by 20% via the portfolio rebalancing channel, especially those issued by covid firms. From April to August 2020, the ECB’s corporate bond purchases failed to improve liquidity or credit risks. The sovereign bond purchases lowered the Z-spread of eligible bonds – mainly in the covid sector – by one bp for every 1 billion bond purchases. While sovereign bond purchases lowered corporate credit spreads, the corporate bond purchases did not, and overall, QE did not improve liquidity