Transaction Costs, Trade Throughs, and Riskless Principal Trading in Corporate Bond Markets

Abstract

This study analyzes the costs of trading bonds using previously unexamined quotations data consolidated across several electronic bond trading venues. Much bond market trading is now electronic, but the benefits largely accrue to dealers because their customers often do not trade at the best available prices. The trade through rate is 43%; the riskless principal trade (RPT) rate is above 42%; and 41% of customer trade throughs appear to be RPTs. Average customer transaction costs are 85 bp for retail-size trades and 52 bp for larger trades. Estimated total transaction costs for the year ended March 2015 are above $26 billion, of which about $0.5 billion is due to trade-through value while markups on customer RPTs transfer $0.7 billion to dealers. Small changes in bond market structure could substantially improve bond market quality.

Keywords: Bond market liquidity, transaction costs, riskless principal trades, trade throughs, effective bid/ask spreads, dealers, brokers, pre-trade transparency, TRACE

JEL Classification: G12, G19, G24, G28