Informed Trading in Government Bond Markets

Abstract

We show that both hedge funds and mutual funds contribute to the price discovery in the government bond market using comprehensive administrative data from the UK. Our sample covers virtually all secondary market trades in gilts and contains detailed information on each individual transaction, including the identities of both counterparties. Hedge funds’ daily trading positively forecasts gilt returns in the following one to five days, which is fully reversed in the following months. Part of this short-term return pattern is due to hedge funds’ ability to forecast other investors’ future order flows. Mutual funds’ trading also positively forecasts bond returns but at a longer horizon, over the next one to two months, which does not revert in the following year. Additional analyses reveal that mutual funds’ superior performance is likely due to their ability to forecast future movements in short-term yields.

Keywords: government bond returns, return predictability, yield curve, asset managers