Providing Liquidity in an Illiquid Market: Dealer Behavior in U.S. Corporate Bonds

66 Pages Posted: 1 Jun 2017 Last revised: 21 Jul 2018

See all articles by Michael A. Goldstein

Michael A. Goldstein

Babson College - Finance Division

Edith S. Hotchkiss

Boston College - Carroll School of Management

Date Written: May 18, 2018

Abstract

We examine market making behavior of dealers for 55,988 corporate bonds, many of which trade infrequently. Dealers have a substantially higher propensity to offset trades within the same day rather than committing capital for longer periods for riskier and less actively traded bonds. Dealers’ holding periods do not decline with a bond’s prior trading activity, and in fact are lowest for some of the least active bonds. As a result, cross sectional estimates of roundtrip trading costs do not increase as prior trading activity declines. Our results suggest that dealers endogenously adjust their behavior to mitigate inventory risk from trading in illiquid and higher risk securities, balancing search and inventory costs in equilibrium such that observed spreads can appear invariant to expected liquidity.

Keywords: Corporate Bond Illiquidity, Capital Commitment, Dealer Inventory, Market-Making, transparency, TRACE, transaction costs

JEL Classification: G14, G23, G24, G28

Suggested Citation

Goldstein, Michael A. and Hotchkiss, Edith S., Providing Liquidity in an Illiquid Market: Dealer Behavior in U.S. Corporate Bonds (May 18, 2018). Available at SSRN: https://ssrn.com/abstract=2977635 or http://dx.doi.org/10.2139/ssrn.2977635

Michael A. Goldstein

Babson College - Finance Division ( email )

320 Tomasso Hall
Babson Park, MA 02457-0310
United States
781-239-4402 (Phone)
781-239-5004 (Fax)

HOME PAGE: http://faculty.babson.edu/goldstein/

Edith S. Hotchkiss (Contact Author)

Boston College - Carroll School of Management ( email )

140 Commonwealth Avenue
Department of Finance Fulton Hall, Room 330
Chestnut Hill, MA 02467
United States
617-552-3240 (Phone)
617-552-0431 (Fax)

Register to save articles to
your library

Register

Paper statistics

Downloads
318
Abstract Views
1,438
rank
94,517
PlumX Metrics