Dealer Behavior and the Trading of Newly Issued Corporate Bonds

Abstract

This study examines dealer behavior and trading activity for a sample of 3,181 newly issued corporate bonds, focusing on underpricing at issuance and subsequent price dispersion. Unlike the equity market, the measured underpricing is the result of both an ex-ante pricing decision made by the bonds' underwriters and significant price dispersion that occurs in the after-market for trading corporate bonds. For the full sample, underpricing averages 45 basis points (BP) for investment grade and 124 BP for high yield offerings. In the aftermarket, customers purchasing a bond on the same day from the same dealer frequently pay prices differing by over $2 (per $100 face amount). However, the introduction of transparency is associated with a reduction in underpricing and aftermarket price dispersion. Whether these gains are potentially passed on to issuing companies is less clear, as non-syndicate member dealers account for a significant proportion of after-market trading activity and price dispersion. Finally, regardless of transparency regime, there is no evidence that dealers in newly issued bonds accumulate significant inventory positions, even when issues subsequently trade below the offering price.

Keywords: corporate bonds, transparency, liquidity, TRACE, underpricing

JEL Classification: G14, G24, G32