Size Effects in the Pricing of Large Orders
Financial Markets, Institutions and Instruments, 2012
41 Pages Posted: 24 Jul 2012
Date Written: February 1, 2012
Large orders for corporate bonds get preferential treatment unlike large orders for stocks on the NYSE. A structural explanation, namely, that the corporate bond market is dealer-dominated has been offered for the favorable pricing. In this paper, we offer an additional explanation, namely, that the improved pricing for large orders is due to the net impact such orders have on a market maker’s costs. Using a data sample that is substantially free of timing mismatch, we support our assertion by sorting the sample into ‘brokered’ trades, which are trades where the dealer merely crosses buy and sell orders and ‘inventoried’ trades, where the dealer trades out of his inventory. We find that large orders raise information costs, but lower inventory costs for ‘inventoried’ trades. The net result is a smaller price advantage than received by large orders on ‘brokered’ trades which are not subject to these costs.
Keywords: corporate bonds, market micro-structure, TRACE
JEL Classification: G10, G24
Suggested Citation: Suggested Citation