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.

Related research

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Is This Normal? The Cost of Assuming that Derivatives Have Normal Returns

Staff working paper 2024-46 Radoslav Raykov
Derivatives exchanges often determine collateral requirements, which are fundamental to market safety, with dated risk models assuming normal returns. However, derivatives returns are heavy-tailed, which leads to the systematic under-collection of collateral (margin). This paper uses extreme value theory (EVT) to evaluate the cost of this margin inadequacy to market participants in the event of default.
Content Type(s): Staff research, Staff working papers JEL Code(s): G, G1, G10, G11, G2, G20 Research Theme(s): Financial markets and funds management, Market functioning, Financial system, Financial stability and systemic risk, Financial system regulation and oversight

An Anatomy of Firms’ Political Speech

Staff working paper 2024-37 Pablo Ottonello, Wenting Song, Sebastian Sotelo
We study the distribution of political speech across U.S. firms. We develop a measure of political engagement based on firms’ communications (earning calls, regulatory filings, and social media) by training a large language model to identify statements that contain political opinions. Using these data, we document five facts about firms’ political engagement.
Content Type(s): Staff research, Staff working papers JEL Code(s): D, D2, D22, D6, D63, G, G4, G41, L, L1, L11, L2, L20 Research Theme(s): Financial markets and funds management, Market structure

Consumer Credit Regulation and Lender Market Power

Staff working paper 2024-36 Zachary Bethune, Joaquín Saldain, Eric R. Young
We investigate the welfare consequences of consumer credit regulation in a dynamic, heterogeneous-agent model with endogenous lender market power. Lenders post credit offers and borrowers—some informed and others uninformed—apply for credit. We calibrate the model to match characteristics of the unsecured consumer credit market and use the calibrated model to evaluate interest rate ceilings.
Content Type(s): Staff research, Staff working papers JEL Code(s): D, D1, D15, D4, D43, D6, D60, D8, D83, E, E2, E21, G, G5, G51 Research Theme(s): Financial markets and funds management, Market functioning, Financial system, Financial institutions and intermediation, Financial stability and systemic risk, Household and business credit

Estimating the Portfolio-Balance Effects of the Bank of Canada’s Government of Canada Bond Purchase Program

Staff working paper 2024-34 Antonio Diez de los Rios
Using a novel dynamic portfolio balance model of the yield curve for Government of Canada bonds, I find that the Bank of Canada’s Government of Canada Bond Purchase Program reduced Canadian 10-year and 5-year zero-coupon yields by 84 and 52 basis points, respectively.
Content Type(s): Staff research, Staff working papers JEL Code(s): E, E4, E43, E5, E52, G, G1, G12, H, H6, H63 Research Theme(s): Financial markets and funds management, Market functioning, Models and tools, Economic models, Monetary policy, Monetary policy tools and implementation

Evaluating the portfolio balance effects of the Government of Canada Bond Purchase Program on the Canadian yield curve

Staff analytical note 2024-22 Antonio Diez de los Rios
The Bank of Canada’s Government of Canada Bond Purchase Program, launched in response to the COVID-19 pandemic, lowered the weighted average maturity of the Government of Canada’s debt by approximately 1.4 years. This in turn reduced Canadian 10-year and 5-year zero-coupon yields by 84 and 52 basis points, respectively.
Content Type(s): Staff research, Staff analytical notes JEL Code(s): E, E4, E43, E5, E52, G, G1, G12, H, H6, H63 Research Theme(s): Financial markets and funds management, Market functioning, Monetary policy, Monetary policy tools and implementation
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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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