37 Pages Posted: 28 Jul 2010
Date Written: July 26, 2010
Using a newly introduced TRACE variable that identifies the side(s) taken by dealers in each trade, I find that 37 percent of dealer-client trades are accompanied by an inter-dealer trade, usually for the exact same quantity and often executed at the exact second as the client trade. All but 0.4 percent of these trade pairs would involve a non-negative profit for a dealer who was involved in both trades. Pairing is much more common for small trades - 46 percent of trades under $100,000 are paired, but only 4.5 percent of trades of $500,000 and above. Controlling for trade size, pairing is less common for trades by institutional clients. Paired trades involve higher trading costs, which are split roughly 50-50 between the pairing dealer and the dealer ultimately taking the other side. Taken together, the evidence suggests that pairing is a symptom of clients being unable to search over the entire market, producing nearly risk-free trading profits for dealers with client relationships or contractual rights to handle order flow.
Keywords: Execution quality, trading costs, dealer markets, fixed income, proprietary trading, TRACE
JEL Classification: G24, G18
Suggested Citation: Suggested Citation