An anatomy of the 2022 gilt market crisis

The Prudential Regulation Authority, PRA, has published a new working paper in which it presents the findings from an analysis of the causes and consequences of the yield hikes in UK gilts in September and October 2022. The paper thereby looks at „market liquidity, investor behaviour and price dynamics“ and lays down how the initial yield hike was triggered and the consequences such hikes had on LDI fund behavior, market intermediaries, and the financial market as a whole.
The main findings of the analysis are briefly noted below (as quoted); for more information, please consult the working paper itself:
1. pre-crisis derivative positions of the LDI-PI [liability-driven investors – pension-insurance] sector were predictive of their gilt sales during the crisis;
2. only three firms were responsible for over 70% of LDI-PI gilts sales to the dealer sector, consistent with the concentrated nature of the LDI-PI market;
3. selling pressure started in linkers (across all maturities), followed by nominals, with evidence pointing to consistent price pressures on yields;
4. transaction costs soared, especially in smaller trade sizes, at smaller dealers, and at clients other than LDI-PI firms too – indicative of illiquidity spillovers across assets, dealers and clients;
5. dispersion of transaction prices jumped, and the cross-dealer component remained high throughout the crisis, indicative of intermediation frictions; and
6. hedge funds were compensated for providing liquidity during the market turbulence.