Assessing Gains from Primary Market Allocations in Corporate Bonds

Abstract

Different market characteristics and investor behavior render the use of underpricing, widely used for equity IPOs, inadequate as a measure of gains from primary market allocations in corporate bonds. We propose a measure that reflects the illiquidity costs that investors save by avoiding acquiring the new bonds in secondary market and show that it can far exceed underpricing. We validate the measure by linking it to changes in secondary market liquidity arising from bond characteristics or induced by regulatory changes. We illustrate the value of the new measure by using it to document that “favoritism” in primary market allocations increases when secondary market liquidity is low.

Keywords: Corporate Bond Issuance, Underpricing, Primary Market Allocation, Secondary Market Liquidity

JEL Classification: G20, G22, G24, G28