Price Discovery in Government Bond Markets

Abstract

This paper investigates the process of price discovery in government bond markets. By using a new data set including interdealer trades, customer trades, trade types and dealer identities, the paper explores the role of dealers in the price formation process and seeks to identify their sources of information. At the aggregate level the results show that interdealer order flow is highly informative, explaining one fourth of daily yield changes, while customer order flow has little explanatory power. At the individual dealer level the results reveal that dealers contribute differently in the price discovery process. Dealers are heterogeneously informed and appear to rely on different sources of information. While some informed dealers extract information from their customer trades, others may extract information by using skill in collecting and interpreting relevant information from other sources. The findings suggest that dealers are not mere intermediaries of customer trades, but play an independent role in the price discovery process in government bond markets.

Keywords: government bond markets, dealers, order flow, price discovery

JEL Classification: G12, G14