Price Discovery in the U.S. Treasury Cash Market: On Principal Trading Firms and Dealers

36 Pages Posted: 17 Nov 2020

See all articles by James Harkrader

James Harkrader

Board of Governors of the Federal Reserve System

Michael Puglia

Board of Governors of the Federal Reserve System

Date Written: November, 2020

Abstract

We explore the following question: does the trading activity of registered dealers on Treasury interdealer broker (IDB) platforms differ from that of principal trading firms (PTFs), and if so, how and to what effect on market liquidity? To do so, we use a novel dataset that combines Treasury cash transaction reports from FINRA’s Trade Reporting and Compliance Engine (TRACE) and publicly available limit order book data from BrokerTec. We find that trades conducted in a limit order book setting have high permanent price impact when a PTF is the passive party, playing the role of liquidity provider. Conversely, we find that dealer trades have higher price impact when the dealer is the aggressive party, playing the role of liquidity taker. Trades in which multiple firms (whether dealers or PTFs) participate on one or both sides, however, have relatively low price impact. We interpret these results in light of theoretical models suggesting that traders with only a “small†informational advantage prefer to use (passive) limit orders, while traders with a comparatively large informational advantage prefer to use (aggressive) market orders. We also analyze the events that occurred in Treasury markets in March 2020, during the onset of the COVID-19 pandemic.

Keywords: Treasury markets, High frequency trading, Market microstructure, Price discovery, Price impact, PTFs, Dealers, Trade Reporting and Compliance Engine, BrokerTec

JEL Classification: G12, G14, G32

Suggested Citation

Harkrader, James and Puglia, Michael, Price Discovery in the U.S. Treasury Cash Market: On Principal Trading Firms and Dealers (November, 2020). FEDS Working Paper No. 2020-96, Available at SSRN: https://ssrn.com/abstract=3732279 or http://dx.doi.org/10.17016/FEDS.2020.096

James Harkrader (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Michael Puglia

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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