Bond Market Structure and Volatility

Abstract

We apply variance ratio methodologies to examine market quality in the US corporate bond market. We find that the open-to-open to close-to-close return variance ratio is greater than one suggesting that the corporate bond market is less efficient during the opening hours than during the closing hours. We show that the higher variance ratio at the open is related to the market power of dealers at the open. Market quality appears to be higher when bond volume and credit rating are low. The results are consistent with dealers behaving strategically to unload risky assets and take on safer assets.

Keywords: Fixed income, market microstructure, variance ratios, corporate bonds, bond dealers, monopolistic power

JEL Classification: G12, G14