Corporate Bond Market Transparency and Transaction Costs

Abstract

Using TRACE data - a complete record of all US OTC secondary trades in corporate bonds - we estimate average transaction cost as a function of trade size for each bond that traded more than nine times in 2003. We find that transaction costs are higher than in equities and decrease significantly with trade size. Highly rated bonds, recently issued bonds, and bonds that will soon mature have lower transaction costs than do other bonds. Costs are lower for bonds with publicly disseminated trade prices, and they drop when the TRACE system starts to publicly disseminate their prices. The results suggest that public traders would significantly benefit if bond prices were made more transparent.

Keywords: Corporate bonds, fixed income, liquidity, transaction cost measurement, effective spreads, TRACE, price transparency, market microstructure, dealers

JEL Classification: G14, G18, G24