Corporate Bond Price Reversals

69 Pages Posted: 31 Oct 2019 Last revised: 4 Nov 2019

See all articles by Alexey Ivashchenko

Alexey Ivashchenko

University of Lausanne, School of Economics and Business Administration (HEC-Lausanne), Institute of Banking and Finance (IBF), Students; Swiss Finance Institute

Date Written: October 22, 2019

Abstract

I demonstrate that investors trade U.S. corporate bonds not only for liquidity reasons but also on private information. Bond dealers let less-informed investors provide liquidity to informed traders and are not adversely selected. I obtain these results by contrasting corporate bond price reversals in bonds with different information asymmetry, trading volume, and dealers' capital commitment. I find strong price reversals that become less pronounced following high-trading-volume days. The effect is the strongest for bonds with high information asymmetry, and when dealers' end-of-day inventory does not change. The results suggest that information reveals itself in prices on high-volume days when dealers do not accept overnight inventory risk. The findings are in line with the predictions of a theoretical model in which investors trade both for liquidity reasons and on private news that arrive independently of changes in inventory. I further show that realized bid-ask spreads are not wide enough to negate reversal profits of high-asymmetry bonds. Such reversal portfolios earn 3% per year after trading cost adjustment. By connecting low market transparency with high non-fundamental price volatility, the paper also contributes to the ongoing policy debate.

Keywords: corporate bonds, trading volume, reversal, informed trading, dealer inventory

JEL Classification: G12, G14

Suggested Citation

Ivashchenko, Alexey, Corporate Bond Price Reversals (October 22, 2019). Available at SSRN: https://ssrn.com/abstract=3473739

Alexey Ivashchenko (Contact Author)

University of Lausanne, School of Economics and Business Administration (HEC-Lausanne), Institute of Banking and Finance (IBF), Students ( email )

CH-1015 Lausanne
Switzerland

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

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