Bond Liquidity and Dealer Inventories: Insights from US and European Regulatory Data

Abstract

Leveraging our access to both regulatory TRACE and ZEN, we construct a sample of approximately 30,000 corporate bonds traded in both relatively transparent (US) and relatively opaque (Europe) jurisdictions. We find that adding heretofore unobserved global trades to transactions that are publicly disseminated through TRACE affects the computation of bond liquidity, dealer inventories, and the relationship between the two. Our results suggest that the liquidity premium for corporate bonds traded in multiple jurisdictions is at least 15-20% higher, depending on credit quality, than what can be inferred from TRACE alone. We find that this liquidity premium differential can be accounted for by dealer inventories that are based on the transactions recorded in the US and European jurisdictions. Our results have important implications for bond (mis)pricing and market efficiency. The direct and indirect evidence reported in this paper contributes to four strands of literature: effects of disclosure and transparency, fixed-income market structure and the role of dealers, cost of immediacy, and the effects of financial regulation on market quality.

Keywords: Corporate bond liquidity, dealer inventories, financial regulation, post-trade transparency, liquidity premium, cost of immediacy

JEL Classification: G10, G12, G23, G14, G15, G18