Asymmetric Information and Trading Strategies: Testing Behavior on the Primary and Secondary T-Bond Markets Around Auction Days

Abstract

We study how dealers behave when there exist parallel markets for the same asset that are characterized by very different degrees of transparency. We show that the optimal trading strategy, depending on the features of the less transparent market, may involve price manipulation. Informed dealers may refrain from trading in the more transparent market in order to exploit their informational advantage in the less transparent one, or they may use the more transparent market in order to manipulate prices. We prove that both strategies (hiding and price manipulation) increase market depth in the more transparent market. We empirically test these conclusions on the Italian Treasury bond market. We estimate dealers strategies jointly on both the primary and the secondary markets. We show that informed dealers place sell orders with other dealers at the time they have higher informational advantage. At the same time they aggressively place bids in the primary market and buy back when the primary market closes. This strategy generates losses in the more transparent market (secondary market) for the period when the less transparent market (primary market) is open and then produces gains once the possibility of affecting the primary market is over. We show that market depth in the more transparent market increases as a results of these strategies.

Keywords: Parallel markets, strategic behavior, empirical microstructure, interdealer-trading, information

JEL Classification: G11, G12, G14, G18