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

Posted: 2 Nov 2005

See all articles by Hendrik Bessembinder

Hendrik Bessembinder

Arizona State University; W.P. Carey School of Business

William F. Maxwell

Southern Methodist University (SMU) - Finance Department

Kumar Venkataraman

Southern Methodist University (SMU) - Finance Department

Multiple version iconThere are 2 versions of this paper

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: Bonds, microstructure, transparency, liquidity externalities

JEL Classification: G10, G14, G13

Suggested Citation

Bessembinder, Hendrik (Hank) and Maxwell, William F. and Venkataraman, Kumar, Market Transparency, Liquidity Externalities, and Institutional Trading Costs in Corporate Bonds. Journal of Financial Economics, Forthcoming, Available at SSRN: https://ssrn.com/abstract=827984

Hendrik (Hank) Bessembinder (Contact Author)

Arizona State University ( email )

PO Box 873906
Tempe, AZ 85207
United States

W.P. Carey School of Business ( email )

W. P. Carey School of Business
PO Box 873906
Tempe, AZ 85287-3906
United States

HOME PAGE: http://https://wpcarey.asu.edu/people/profile/2717225

William F. Maxwell

Southern Methodist University (SMU) - Finance Department ( email )

United States

Kumar Venkataraman

Southern Methodist University (SMU) - Finance Department ( email )

United States
214-768-7005 (Phone)
214-768-4099 (Fax)

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

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