Imagine you are analyzing a low-volume corporate bond for a client’s portfolio. You notice the wide bid-ask spread—the price at which you can sell is significantly lower than the price at which you can buy—which signals high liquidity risk. As a research analyst, this gap acts as a hidden transaction cost that can erode your client’s expected returns. If you recommend this asset, you must factor this ‘friction’ into your valuation model, as the inability to exit the position quickly without moving the price against yourself is a fundamental risk.
This is where market makers serve as the vital ’lubricant’ of the financial markets. A market maker, typically a large bank or a specialized financial institution, commits to quoting both a buy price and a sell price for a specific security continuously. By providing these two-sided quotes, they effectively stand ready to take the opposite side of a trade, thereby narrowing the spread and allowing buyers and sellers to transact without waiting for a perfect counterparty match.
They absorb the temporary supply-demand imbalances that would otherwise result in extreme price volatility or trade failure.
In the Indian debt market, liquidity in many corporate bonds is relatively thin, making the role of market makers even more critical. When a market maker is active, they provide a buffer that lowers the ’execution risk’ for institutional investors. For an analyst, the presence of a market maker allows you to treat a bond as more liquid than its raw trade volume might suggest.
However, if the market maker exits the market during a liquidity crunch, the spread widens dramatically, and the liquidity risk reappears, often when you need to sell the most.
As you draft your investment notes, assessing whether a security has a robust market-making ecosystem is as important as analyzing its credit rating. If a bond lacks consistent market-making support, your recommendation must include a ’liquidity discount’ to account for the potential difficulty in offloading the asset. Ignoring the stability of the market-making mechanism in your analysis is equivalent to assuming a clear road ahead while ignoring the potential for a sudden, unpredictable traffic jam.
Nuance
Check Your Understanding
An analyst observes that a specific corporate bond has a narrow bid-ask spread despite relatively low daily trading volumes. What is the most likely explanation for this observation?
When evaluating liquidity risk for a bond portfolio, why should an analyst be concerned if a primary market maker withdraws from the market?
This is a companion read for Section 12.3 — Risks in Investments from PASS Research Analyst Certification Examination by Akhilesh Gururani, available on Amazon Kindle.
Copyright © 2026 Akhilesh Gururani. All rights reserved.