Financial markets

Financial markets are where savers and borrowers exchange funds. Their well-functioning is critical. This is why we study their structure, participants, regulations and how they are affected by key external changes.

Financial markets consist of markets for money, bonds, equities, derivatives and foreign currencies. It is mainly through these markets that the Bank of Canada’s key policy rate influences interest rates and exchange rates for the Canadian dollar. This, in turn, helps us achieve our monetary policy objectives. As the fiscal agent for the Government of Canada, we are also involved in financial markets through auctions of government securities.

Our research increases our understanding of the structure and functioning of Canadian financial markets and helps us identify ways to support their development and stability.

Examples of areas we are exploring:

  • the ability of and risks to markets absorbing higher levels of government debt
  • what motivates international investors, such as US hedge funds, to participate in the Government of Canada bond market
  • the risks to financial stability from new non-bank players entering the business of intermediating markets
  • important things to consider when designing central bank programs that supply liquidity to market participants
  • the impacts on market structure from things like artificial intelligence and tokenized assets

Government debt market

In recent years, governments around the world, including in Canada and the United States, have issued more debt to support their economies. This large supply of government securities may lead to funding challenges and could distort asset markets. Our research aims to understand the capacity of markets to absorb this debt and its effect on market functioning, financial stability and the transmission of monetary policy.

Market structure and regulation

Another key part of our research is understanding how financial markets adapt to the evolving financial environment and how regulation safeguards stability and market functioning. In many countries, including Canada, fixed-income markets are still primarily over the counter and rely heavily on bank-owned dealers. This reliance can create challenges for dealers managing their balance sheets and, in times of stress, may limit funding to the broader economy. At the same time hedge funds and high-frequency, or principal, trading firms are among the new players acting as intermediaries as these markets digitalize. This change brings both benefits and new risks, which we strive to better understand.

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Covariates Hiding in the Tails

Staff working paper 2021-45 Milian Bachem, Lerby Ergun, Casper G. de Vries
We characterize the bias in cross-sectional Hill estimates caused by common underlying factors and propose two simple-to-implement remedies. To test for the presence, direction and size of the bias, we use monthly US stock returns and annual US Census county population data.

Rising US LNG Exports and Global Natural Gas Price Convergence

Staff discussion paper 2021-14 Robert Ialenti
We assess how rising exports of US liquefied natural gas affect the convergence of natural gas prices worldwide. Our results may have implications for the development of future LNG export capacity in Canada.

Reaching for yield or resiliency? Explaining the shift in Canadian pension plan portfolios

“Reach for yield”—This is the commonly heard explanation for why pension plans shift their portfolios toward alternative assets. But we show that the new portfolios also hold more bonds, offer lower average returns and produce smaller and less volatile solvency deficits. These shifts are part of a broader strategy to reduce solvency risk.

Centralizing Over-the-Counter Markets?

Staff working paper 2021-39 Jason Allen, Milena Wittwer
Would a shift in trading in fixed-income markets—from over the counter (bilateral trading) to a centralized electronic platform—improve welfare? We use trade-level data on the secondary market for Government of Canada debt to answer this question.

Tariffs and the Exchange Rate: Evidence from Twitter

Staff working paper 2021-36 Dmitry Matveev, Francisco Ruge-Murcia
Do tariffs affect exchange rates? We look at President Trump’s tweets during talks on the North American Free Trade Agreement and find that anticipation of higher tariffs on imports from Canada and Mexico led to an appreciation of the US dollar relative to Canadian and Mexican currency.
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Disclaimer

Bank of Canada staff produce research and analysis to support the work of the Bank and to advance knowledge in the fields of economics and finance. The research is non-partisan and evidence based. All research is produced independently from the Bank’s Governing Council. The views expressed in each paper or article are solely those of the authors and may differ from official Bank of Canada views.

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