Download this Paper Open PDF in Browser

The Value of Trading Relationships in Turbulent Times

54 Pages Posted: 7 Jul 2015 Last revised: 20 Jul 2016

Marco Di Maggio

Harvard Business School; National Bureau of Economic Research (NBER)

Amir Kermani

University of California, Berkeley; National Bureau of Economic Research (NBER)

Zhaogang Song

Johns Hopkins University - Carey Business School

Multiple version iconThere are 2 versions of this paper

Date Written: July 19, 2016

Abstract

This paper investigates how the network of relationships between dealers shapes their trading behavior in the corporate bond market. We show that dealers tend to provide liquidity during periods of distress to the counterparties with whom they have the strongest tie. However, highly connected and systemically important dealers exploit their connections at the expense of peripheral dealers as well as of their clients, charging them higher markups than to other core dealers, especially during high-uncertainty periods. We then exploit the flagship collapse of a large dealer in 2008 as a shock to the network of relationships among dealers. We show that institutions with stronger ties to this dealer are forced to route their trades through longer intermediation chains to contact new counterparties, which charge them significantly higher prices. Moreover, we provide evidence suggesting that dealers did not lean against the wind; instead they drastically reduced their inventory during the financial crisis. These results inform the debate on the risks related to the interconnectedness of the financial system by showing how it might be a source of market fragility and illiquidity.

Keywords: OTC markets, network, corporate bonds, crisis, intermediation chains, leaning against the wind

JEL Classification: G12, G14, G24

Suggested Citation

Di Maggio, Marco and Kermani, Amir and Song, Zhaogang, The Value of Trading Relationships in Turbulent Times (July 19, 2016). Journal of Financial Economics (JFE), Forthcoming; Columbia Business School Research Paper No. 15-65. Available at SSRN: https://ssrn.com/abstract=2597938 or http://dx.doi.org/10.2139/ssrn.2597938

Marco Di Maggio (Contact Author)

Harvard Business School ( email )

Boston, MA 02163
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Amir Kermani

University of California, Berkeley ( email )

2220 Piedmont Ave
Berkeley, CA 94720
United States

HOME PAGE: http://faculty.haas.berkeley.edu/amir/research/research.html

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Zhaogang Song

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States

Paper statistics

Downloads
568
Rank
38,754
Abstract Views
2,445