Interdealer Price Dispersion
101 Pages Posted: 17 Oct 2022 Last revised: 31 Jan 2023
Date Written: October 5, 2022
Intermediation capacity varies across dealers and, as a result, misallocation of credit risk reduces the risk-bearing capacity of the dealer sector and increases effective market-level risk aversion. When the efficient reallocation of credit risk within the dealer sector is impaired, interdealer price dispersion increases. Empirically, interdealer price dispersion is a strong determinant of yield spread changes. When interdealer price dispersion is high, bond prices are low. Interdealer price dispersion explains a substantial portion of bond yield spread changes, the cross-section of bond returns, and the basis between yield spread changes and changes in fair-value spreads. We conclude that frictions within the dealer sector reduce the risk-bearing capacity of intermediaries and are thus crucial for intermediary bond pricing.
Keywords: OTC markets, intermediaries, dealers, corporate bonds, interdealer price dispersion
JEL Classification: G12
Suggested Citation: Suggested Citation