Size Discount and Size Penalty: Trading Costs in Bond Markets
56 Pages Posted: 22 Apr 2021 Last revised: 12 Aug 2021
Date Written: April 20, 2021
We show that larger trades incur lower trading costs in government bond markets (“size discount”), but costs increase in trade size after controlling for clients’ identities (“size penalty”). The size discount is driven by the cross-client variation of larger traders obtaining better prices, consistent with theories of trading with imperfect competition. The size penalty, driven by within-client variation, is larger for corporate bonds and during major macroeconomic surprises as well as during COVID-19. These differences are larger among more sophisticated clients, consistent with theories of asymmetric information. We propose a trading model with bilateral bargaining and adverse selection to rationalize the co-existence of the size penalty and discount.
Keywords: Trading Costs, Government and Corporate Bonds, Trader Identities, Size Discount, Size Penalty
JEL Classification: G12, G14, G24
Suggested Citation: Suggested Citation