Market Depth of Israeli Corporate Bonds: Comparison to OECD Member States

This research aims to study market depth of Israeli High Quality Corporate Bonds (HQCB), as compared with OECD member states. The motivation stems from International Accounting Standard 19 (IAS-19), which Israel adopted recently, whereby long-term employee benefits should be discounted by reference to market yields on local HQCB at the end of the reporting period. If there is no deep market in HQCB, IAS-19 requires that the discount rate be determined based on local government bond yields. The choice between the two rates might have a substantial impact on the entity`s financial statements (For example, in Israel Electric the impact is about 4 billion Shekels, and in the big banks between 0.5-2 billions). However, IAS-19 does not provide a clear definition of the criteria by which one would define High Quality of Corporate bonds, and it is not specific about the particular definition of market depth. This study aims to develop a coherent and unified framework for defining which bonds may be considered High Quality, and how market depth can and should be measured. By answering these questions, we aim to provide a uniform and comprehensive methodology to explore whether a country can be classified as having a deep market, or not. Our first step has already been conducted, where we examined whether the Israeli HQCB market may be considered deep or not.

Market depth is often defined as a market in which traders’ transactions have small impact on prices. To measure depth, we examined the relevance of various financial variables as predictors for a binary market-depth indicator. We applied Linear Discriminant Analysis (LDA) over recent in-sample data from 31 markets, obtained from the World Bank. The analysis focuses on in-sample performance from one to three years before and after the global financial crisis of 2008. Results show that the relative sizes of deposits in financial institutions as well as the private debt securities to GDP are robust predictors for financial market depth. Out-of-sample results for the Israeli market show discriminant scores within the range of the deep markets group with evaluated group membership above 99%, outperforming the classification results of well-developed markets such as Italy, Finland and Sweden. The findings of this research have been accepted by the Israeli Securities Authority, who declared that Israel has a deep market in HQCBs, and hence instructed on immediate implementation of IAS-19`s requirements.