Market Making and Proprietary Trading in the US Corporate Bond Market

68 Pages Posted: 13 Feb 2020

See all articles by Hugues Dastarac

Hugues Dastarac

Banque de France - Department of Monetary Policy and Financial Research

Date Written: February 2020

Abstract

I study broker-dealers' trading activity in the US corporate bond market. I find evidence of broker-dealer market making when customers both buy and sell a bond in a day, which happens half of the time: as predicted by market making theories with adverse selection or inventory costs, prices go down (up) as customers sell (buy). Otherwise, evidence is in favor of proprietary trading as in limits of arbitrage theories: prices go up (down) when customers sell (buy), and dealers buy (sell) bonds that are relatively cheap (expensive). Proprietary trading is reduced after the crisis. Relatedly I show that before the crisis, large broker-dealers borrowed and sold Treasury bonds in amounts similar to their corporate bond holding, but not after. I give suggestive evidence that they were subject to a severe tightening of their margin constraints as early as July 2007, in particular following increased Treasury bond volatility.

Keywords: Credit Spreads, Dealer behavior, corporate bonds, limits of arbitrage, Volcker rule

JEL Classification: G20

Suggested Citation

Dastarac, Hugues, Market Making and Proprietary Trading in the US Corporate Bond Market (February 2020). Available at SSRN: https://ssrn.com/abstract=3536907 or http://dx.doi.org/10.2139/ssrn.3536907

Hugues Dastarac (Contact Author)

Banque de France - Department of Monetary Policy and Financial Research ( email )

France

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