Permanent Trading Impacts and Bond Yields

Abstract

We analyze four years of transaction data for euro-area sovereign bonds traded on the MTS electronic platform. In order to measure the informational content of trading activity, we estimate the permanent price response to trades. We find not only strong evidence of information asymmetry in sovereign bond markets, but we also show the relevance of information asymmetry in explaining the cross-sectional variations of bond yields across a wide range of bond maturities and countries. Our results confirm that trades of more recently issued bonds and longer maturity bonds have a greater permanent effect on prices. We compare the price impact of trades for bonds across different maturity categories and find that trades of French and German bonds have the highest long-term price impact in the short maturity class whereas trades of German bonds have the highest permanent price impacts in the long maturity class. More importantly, we study the cross-section of bond yields and, after controlling for conventional factors, we find that investors demand higher yields for bonds with larger permanent trading impacts. Interestingly, when investors face increased market uncertainty they require even higher compensation for information asymmetry

Keywords: Bond markets, Liquidity, Information asymmetry

JEL Classification: G12, G14, G15, H81