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Market Transparency, Liquidity Externalities, and Institutional Trading Costs in Corporate Bonds

54 Pages Posted: 8 Jan 2005  

Hendrik Bessembinder

Arizona State University

William F. Maxwell

SMU - Cox School

Kumar Venkataraman

Southern Methodist University (SMU) - Edwin L. Cox School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: October 2005

Abstract

We develop a simple model of the effect of transaction reporting on trade execution costs and test it using a sample of institutional trades in corporate bonds, before and after the initiation of public transaction reporting through the TRACE system. The results indicate a reduction of approximately 50% in trade execution costs for bonds eligible for TRACE transaction reporting, and consistent with the model's implications, also indicate the presence of a liquidity externality that results in a 20% reduction in execution costs for bonds not eligible for TRACE reporting. The key results are robust to allowances for changes in variables, such as interest rate volatility and trading activity, which might also affect execution costs. We also document decreased market shares for large dealers and a smaller cost advantage to large dealers post-TRACE, suggesting that the corporate bond market has become more competitive after TRACE implementation. These results reinforce that market design can have first-order effects, even for sophisticated institutional customers.

Keywords: transparency, corporate bonds, trace, microstructure,

JEL Classification: G14, G18, G28

Suggested Citation

Bessembinder, Hendrik and Maxwell, William F. and Venkataraman, Kumar, Market Transparency, Liquidity Externalities, and Institutional Trading Costs in Corporate Bonds (October 2005). AFA 2006 Boston Meetings, Forthcoming. Available at SSRN: https://ssrn.com/abstract=644624 or http://dx.doi.org/10.2139/ssrn.644624

Hendrik (Hank) Bessembinder (Contact Author)

Arizona State University ( email )

PO Box 873906
Tempe, AZ 85207
United States

William F. Maxwell

SMU - Cox School ( email )

Maguire Bldg, RM 440C
Dallas, TX, TX 75214
United States

Kumar Venkataraman

Southern Methodist University (SMU) - Edwin L. Cox School of Business ( email )

P.O. Box 750333
Dallas, TX 75275-0333
United States
214-768-7005 (Phone)
214-768-4099 (Fax)

HOME PAGE: http://people.smu.edu/kumar/

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