Over-the-Counter Market Frictions and Yield Spread Changes
66 Pages Posted: 10 Dec 2017 Last revised: 23 Nov 2018
Date Written: November 21, 2018
We empirically study whether systematic over-the-counter (OTC) market frictions drive the large unexplained common factor in yield spread changes. Using transaction data on U.S. corporate bonds, we find that marketwide inventory, search, and bargaining frictions explain 23.4% of the variation of the common component. Systematic OTC frictions thus substantially improve the explanatory power of yield spread changes and account for one-third of their total explained variation. Search and bargaining frictions combined explain more in the common dynamics of yield spread changes as inventory frictions. Our findings support the implications of leading theories of intermediation frictions in OTC markets.
Keywords: Corporate bond market, over-the-counter market, yield spread changes, intermediation frictions, dealer market
JEL Classification: G10, G12, G20
Suggested Citation: Suggested Citation