Microstructure of the Bid-Ask Spreads of Russian Sovereign Bonds (1996-2000): Spreads as Indicators of Liquidity

Abstract:     
In this paper, we investigate components of the bond bid-ask spreads for the emerging market in Russian sovereign bonds in the late 90s. We identify the size of the bid-ask spreads with liquidity because many of trades in illiquid securities happen in closed transactions and accurate information on the price-volume reaction is not available. Following Stoll (2003), we distinguish three components of the bid-ask spread: trade execution cost, inventory maintenance cost and information asymmetry, or adverse selection. We argue, that the information asymmetry, associated with the presence of informed traders, contributes up to 50% into the unpredictable component of the bid-ask spread.

The largest changes in informed trading sentiment, which we identified, cluster around September 97 and August 98. We attribute them to the negative reaction of insiders on the handling of Asian financial crisis by the IMF and generally positive reaction to the decision of Russian Government to keep its Eurobonds out of default.

Keywords: Informed trading, microstructure of emerging markets, Russian Federation debt, bond spreads, Brock-Dechert-Scheinkman (BDS), Stock-Watson and Chow tests

JEL Classification: G12, G13

Accepted Paper Series