How Do Inventory Costs Affect Dealer Behavior in the US Corporate Bond Market? PDF Download
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Author: Oliver Randall
Publisher:
ISBN:
Category :
Languages : en
Pages : 61
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Book Description
I show that dealer behavior in the US corporate bond market is consistent with dealers bearing a time-varying cost of holding inventory. Liquidity is worse when inventory costs increase, especially for bonds with lower credit ratings, customers with lower bargaining power, and larger trades. When inventory costs increase, dealers sell more high yield bonds, but sell less investment grade, suggesting a flight to quality. Inventory costs don't affect dealers' trades immediately unwound in the inter-dealer market, but do affect the rate at which these trades occur, as dealers' willingness and ability to risk-share in the inter-dealer market change.
Author: Oliver Randall
Publisher:
ISBN:
Category :
Languages : en
Pages : 61
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Book Description
I show that dealer behavior in the US corporate bond market is consistent with dealers bearing a time-varying cost of holding inventory. Liquidity is worse when inventory costs increase, especially for bonds with lower credit ratings, customers with lower bargaining power, and larger trades. When inventory costs increase, dealers sell more high yield bonds, but sell less investment grade, suggesting a flight to quality. Inventory costs don't affect dealers' trades immediately unwound in the inter-dealer market, but do affect the rate at which these trades occur, as dealers' willingness and ability to risk-share in the inter-dealer market change.
Author: Antje Berndt
Publisher:
ISBN:
Category :
Languages : en
Pages : 75
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Book Description
We propose an equilibrium model of over-the-counter corporate bond trading with short selling, asymmetric information and dealer inventory costs. The model predicts that higher inventory costs impose implicit short-sale constraints on informed investors and are thus associated with lower price efficiency. We construct bond-level proxies for inventory costs and provide empirical evidence in support of the model's prediction. Our findings suggest that tighter post-GFC regulation may have had unintended consequences for corporate bond market quality.
Author: Nils Friewald
Publisher:
ISBN:
Category :
Languages : en
Pages : 44
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Book Description
Inventory models of dealership markets imply that intermediaries reduce their exposure to inventory risk by offering prices different from fundamental values. Therefore, inventory levels should affect asset prices and thus returns. We explore the cross-sectional relation between US corporate bond inventories and returns. Our findings provide strong support for the asset pricing implication of inventory models, that is, the risk-adjusted return of a high-minus-low inventory-sorted portfolio is 21 basis points per week. Furthermore, we examine several drivers of the inventory risk premium; for example, we emphasize the importance of inventory risk sharing in pricing bonds.
Author: Michael A. Goldstein
Publisher:
ISBN:
Category :
Languages : en
Pages : 66
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Book Description
We examine market making behavior of dealers for 55,988 corporate bonds, many of which trade infrequently. Dealers have a substantially higher propensity to offset trades within the same day rather than committing capital for longer periods for riskier and less actively traded bonds. Dealers' holding periods do not decline with a bond's prior trading activity, and in fact are lowest for some of the least active bonds. As a result, cross sectional estimates of roundtrip trading costs do not increase as prior trading activity declines. Our results suggest that dealers endogenously adjust their behavior to mitigate inventory risk from trading in illiquid and higher risk securities, balancing search and inventory costs in equilibrium such that observed spreads can appear invariant to expected liquidity.
Author: Andreas C. Rapp
Publisher:
ISBN:
Category :
Languages : en
Pages : 59
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Book Description
Corporate bond dealers build up considerable inventories for which they rely on short-term funding. I provide empirical evidence that dealers' inventory financing constraints are a crucial determinant of the costs of their liquidity provision in corporate bond markets. Constructing a unique dataset that links dealer identities with transaction prices, I show that dealer-specific financing constraints (as proxied by their CDS spreads) explain a substantial part of the variation in the inventory cost component of the effective bid-ask spread. Compared to low volatility bonds, the liquidity provision of high volatility bonds is more sensitive to inventory costs, especially during periods of funding stress. Finally, exploiting a quasi-natural experiment, I show that the relaxation of funding constraints through a Federal Reserve emergency credit facility temporarily alleviates liquidity problems among eligible dealers.
Author: Evelyn Rill
Publisher: GRIN Verlag
ISBN: 3668080305
Category : Political Science
Languages : en
Pages : 40
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Book Description
Bachelor Thesis from the year 2015 in the subject Business economics - Economic Policy, grade: 1,3, University of Frankfurt (Main) (Faculty of Economics and Business Administration), course: Chair of Corporate Finance, language: English, abstract: Due to the importance of inventories and the fact that asymmetric information models are extensively discussed in literature, this thesis exclusively focuses on inventory control models and provides a survey of theory and empirical results on the role of inventory in the price formation process. Because most of the relevant literature is based on the U.S. exchange market, this thesis is mainly confined on inventory control of specialists on the New York Stock Exchange (NYSE) and of dealers on the National Association of Securities Dealers (NASDAQ). To understand the costs of holding inventory, Section 2 introduced three important drivers of inventory: capital constraints, liquidity and volatility. Section 3 summarises the effect of market maker inventory and its costs on liquidity and how this affects the bid-ask spread. In Section 4, the impact of inventory on asset prices, especially of inventory levels, is discussed in more detail. Section 5 briefly turns to changes in market structure and how they affect the role of traditional market makers and their inventories. Section 6 finally concludes.
Author: Louis H. Ederington
Publisher:
ISBN:
Category :
Languages : en
Pages : 52
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Book Description
Utilizing the large subset of trades in which dealers act purely as agents, we decompose dealer spreads in U.S. corporate bond OTC markets into components arising from: 1) dealers' market-making role, and 2) their role as agents for their non-dealer customers. We investigate the determinants of both components. We find that agent-related spreads are large and comparable in magnitude to market-making spreads. In their role as agents, dealers face liquidity-search and customer interface costs, while in their role as market makers they face inventory and asymmetric information costs. Consistent with this, we find that while market-making spreads are strongly correlated with market risk variables, agent-related spreads are not, depending instead on liquidity driven variables. While market-making spreads are inversely related to trade size, agent-related spreads increase with trade size before leveling off and then declining -- possibly indicating that agent-dealers devote lesser search time to relatively smaller trades. While market-making dealer spreads are positively correlated with risk variables, whether trading directly with non-dealer customers or with dealers acting purely as agents, the difference between the former and the latter is negatively correlated with risk variables implying that market-making dealers benefit more from direct interaction with traders when risk and information asymmetry is higher, consistent with dealers deriving information-related benefits from their customer interface. Except for very small trades, explicit transaction costs of non-dealer customers are lower when they trade directly with market-making dealers than when they route trades through a dealer acting purely as an agent. Finally, we show that existing studies have underestimated average overall trading costs in the corporate bond market by conflating the spreads of dealers acting purely as agents with full dealer spreads that include both agent and market making costs. Given our findings on the size and economic determinants of agent-related dealer costs, our results have significant implications for the extensive empirical literature on dealer spreads in other OTC markets.
Author: Oliver Randall
Publisher:
ISBN:
Category :
Languages : en
Pages : 55
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Book Description
I show that if dealers are averse to holding inventory, then prices, liquidity, and dealers' inventory positions depend on inventory costs in negotiated over-the-counter markets. The solution to my dynamic equilibrium model rationalizes the following stylized facts in the US corporate bond market:(i) a reduction in dealers' inventories during crises;(ii) a reduction in average trade size since the onset of the financial crisis and tighter regulatory environment;(iii) better prices for customers to buy than sell in the financial crisis;(iv) a generally negative relationship between transaction costs and trade size.The results inform debate on the Volcker Rule.
Author: Michael A. Goldstein
Publisher:
ISBN:
Category :
Languages : en
Pages : 38
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Book Description
This study examines dealer behavior and trading activity for a sample of 3,181 newly issued corporate bonds, focusing on underpricing at issuance and subsequent price dispersion. Unlike the equity market, the measured underpricing is the result of both an ex-ante pricing decision made by the bonds' underwriters and significant price dispersion that occurs in the after-market for trading corporate bonds. For the full sample, underpricing averages 45 basis points (BP) for investment grade and 124 BP for high yield offerings. In the aftermarket, customers purchasing a bond on the same day from the same dealer frequently pay prices differing by over $2 (per $100 face amount). However, the introduction of transparency is associated with a reduction in underpricing and aftermarket price dispersion. Whether these gains are potentially passed on to issuing companies is less clear, as non-syndicate member dealers account for a significant proportion of after-market trading activity and price dispersion. Finally, regardless of transparency regime, there is no evidence that dealers in newly issued bonds accumulate significant inventory positions, even when issues subsequently trade below the offering price.
Author: Paul Schultz
Publisher:
ISBN:
Category :
Languages : en
Pages : 40
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Book Description
In over-the-counter markets, dealer willingness to hold inventory is synonymous with liquidity provision. Using actively-traded corporate bonds over 2005-2014, I show that dealers often avoid taking bonds into inventory by prearranging trades. Dealers who take longer to unwind inventory prearrange more trades. Investors receive higher prices selling to dealers who prearrange trades and pay lower prices buying from them. Dealers unwind inventory mostly through interdealer trades. After the Volcker Rule was finalized, dealers were more reluctant to takes bonds into inventory, were more likely to offset trades within a day, and unwound inventory positions more quickly.
