Corporate Bond Market Transaction Costs and Transparency

Using a complete record of U.S. over‐the‐counter (OTC) secondary trades in corporate bonds, we estimate average transaction costs as a function of trade size for each bond that traded more than nine times between January 2003 and January 2005. We find that transaction costs decrease significantly with trade size. Highly rated bonds, recently issued bonds, and bonds close to maturity have lower transaction costs than do other bonds. Costs are lower for bonds with transparent trade prices, and they drop when the TRACE system starts to publicly disseminate their prices. The results suggest that public traders benefit significantly from price transparency.     

Dealer intermediation and price behavior in the aftermarket for new bond issues

Municipal bonds trade in decentralized broker-dealer markets, and are underpriced when issued, but unlike equities the average price rises slowly over several days. Newly issued municipal bonds have high levels of price dispersion and the average price rises because the mix of trade sizes changes over time. While large trades occur close to the reoffering price, small trades occur between the reoffering price to as much as 5% above the reoffering price. Using a mixed-distribution model we quantify the losses uninformed traders or issuers give up to broker-dealers.     

Market Segmentation and the Cost of Capital in a Domestic Market: Evidence from Municipal Bonds

We study the implications of market segmentation in a domestic setting, the US municipal bond market. A (state‐level) segmentation of this market emerges from asymmetric tax exemption. Municipal bond investors are exempt from state and local taxes on bonds issued by their own state, but not on bonds issued by other states. We demonstrate that market segmentation imposes significant costs on both issuers and investors in the form of higher yields and higher costs of financial intermediation. Our results provide insight into some well‐documented artifacts of the municipal bond market, such as high yields and the popularity of insurance.     

Taxes on Tax‐Exempt Bonds

Implicit tax rates priced in the cross section of municipal bonds are approximately two to three times as high as statutory income tax rates, with implicit tax rates close to 100% using retail trades and above 70% for interdealer trades. These implied tax rates can be identified because a portion of secondary market municipal bond trades involves income taxes. After valuing the tax payments, market discount bonds, which carry income tax liabilities, trade at yields around 25 basis points higher than comparable municipal bonds not subject to any taxes. The high sensitivities of municipal bond prices to tax rates can be traced to individual retail traders dominating dealers and other institutions.     

The market for new issues of municipal bonds: The roles of transparency and limited access to retail investors

I examine how transparency and interdealer trading affects prices investors pay in municipal bond offerings. Real-time trade reporting for municipal bonds started January 31, 2005. The dispersion of purchase prices fell sharply at that time. There was little impact on average markups for most trades, but they increased for purchases of more than $100,000. Bonds often pass through a series of dealers before being placed with a buy-and-hold investor. As the interdealer trades progress, trade sizes decline and trade prices rise. Markups on investor purchases increase with the amount of interdealer trading before the trade.     

The Role and Impact of Financial Advisors in the Market for Municipal Bonds

Significantly more and more issuers of municipal bonds use the services of financial advisors during the bond issuance process. We investigate the benefits to issuers and market participants arising from the role of financial advisors in the issuance of municipal bonds. Using a large sample of 9,493 tax-exempt municipal bonds, we show that financial advisors have significant impact on borrowing costs, reoffering yields and underwriter gross spreads. Our results are more pronounced for revenue bonds, particularly for negotiated revenue issues. In addition, our results show significant advantages to using a financial advisor for refunding issues supporting the view that financial advisors play important roles for more complex issues. Our results are consistent with the interpretation that financial advisors provide important and useful services resulting in monitoring and information asymmetry reduction benefits accruing to issuers and market participants.      

From Implicit to Explicit: The Impact of Disclosure Requirements on Hidden Transaction Costs

This paper provides evidence that disclosing corporate bond investors' transaction costs (markups) affects the size of the markups. Until recently, markups were embedded in the reported transaction price and not explicitly disclosed. Without explicit disclosure, investors can estimate their markups using executed transaction prices. However, estimating markups imposes information processing costs on investors, potentially creating information asymmetry between unsophisticated investors and bond‐market professionals. We explore changes in markups after bond‐market professionals were required to explicitly disclose the markup on certain retail trade confirmations. We find that markups decline for trades that are subject to the disclosure requirement relative to those that are not. The findings are pronounced when constraints on investors' information processing capacity limit their ability to be informed about their markups without explicit disclosure.     

Transaction costs in an illiquid order‐driven market

Transaction costs in many international equity markets are much larger than those in the USA. This raises questions such as what trade size these reported trading costs relate to and whether investors can reduce trading costs by timing their trades. We show, using data from the order‐driven New Zealand market, that transaction costs are frequently lower for larger trades, particularly in small stocks, and investors are able to reduce costs by timing their transactions. While investors who require immediate execution incur transaction costs that are much higher than reported average costs, patient investors can trade at much better rates.     

Does the Quality of Financial Advice Affect Prices?

Using a large data sample of 58,562 new municipal issues covering the period from 1984 to 2002, we examine whether the quality of advice provided by a financial advisor affects new issue interest costs. We find that higher‐quality financial advisors are associated with statistically significant decreases in new issue yields. The effect of advisor quality on yields is more pronounced for revenue, negotiated, and opaque bond issues than for general obligation and competitively sold issues. However, issuers of revenue or negotiated bonds are more likely to choose a low‐quality advisor.     

Dealer Networks

Dealers in the over‐the‐counter municipal bond market form trading networks with other dealers to mitigate search frictions. Regulatory data show that this network has a core‐periphery structure with 10 to 30 hubs and over 2,000 peripheral broker‐dealers in which bonds flow from periphery to core and partially back. Central dealers charge investors up to double the round‐trip markups compared to peripheral dealers. In turn, central dealers provide immediacy by matching buyers with sellers more directly and prearranging fewer trades, especially during stress times. Investors thus face a trade‐off between execution cost and speed, consistent with network models of decentralized trade.     

When knowledge is power: Evidence from the municipal bond market

I investigate whether access to fundamental information enhances retail investors’ bargaining power, reducing the premium that small municipal bond investors pay over large investors. I find a reduction in this small trade premium after the introduction of an online disclosure repository that lowers retail investors’ information acquisition costs. This finding is limited to issuers whose disclosures are disseminated through the repository. The finding is pronounced for issuers that impose high information acquisition costs on investors ex-ante and those that exhibit high disclosure quality ex-post. These results suggest that as investors’ information sets align, so does their bargaining power with dealers.     

Callable Bonds: Better Value Than Advertised?

Callable bonds allow issuers to manage interest rate risk in the sense that if rates decline, the bonds can be redeemed and replaced with lower‐cost debt. Investors demand a coupon premium for giving issuers this option; and when deciding whether to issue callable or noncall‐able bonds, the issuing companies must determine whether it's worth paying the coupon premium. This article addresses two main questions about the structuring and refunding of callable bonds. The first concerns the value of the call option: At the time of issuance, does it make sense to accept the coupon premium for the option being acquired? The second concerns the optimal timing of a refunding: At refunding, do the cash flow savings provide adequate compensation for the option that is being exercised and hence given up? In perfect markets with no taxes or transactions costs, the average corporate issuer should be indifferent between issuing callable bonds or their noncallable equivalent. But corporate taxes, together with risk management considerations, can lead some issuers to prefer callable bonds, possibly with coupons that otherwise would be unacceptably high. Refunding decisions should be made using the concept of “call efficiency,” which compares the savings (net of transactions costs) from calling to the loss of option value. The latter should also account for any option that is built into the replacement issue. Transaction costs that occur when refunding diminish the value of the call option, and their effect should be factored in at the time of issuance. One way of avoiding such costs is to issue “ratchet” bonds—essentially one‐way floaters that automatically reset lower when rates decline, thus delivering the benefits of callable bonds while eliminating transaction costs.     

Corporate Bond Trading Costs: A Peek Behind the Curtain

In this paper, I use institutional corporate bond trade data to estimate transactions costs in the over-the-counter bond market. I find average round-trip trading costs to be about $0.27 per $100 of par value. Trading costs are lower for larger trades. Small institutions pay more to trade than large institutions, all else being equal. Small bond dealers charge more than large ones. I find no evidence that trading costs more for lower-rated bonds.     

Market transparency,liquidity externalities,and institutional trading costs in corporate bonds

We develop a simple model of the effect of public transaction reporting on trade execution costs and test it using a sample of institutional trades in corporate bonds, before and after initiation of the TRACE reporting system. Trade execution costs fell approximately 50% for bonds eligible for TRACE transaction reporting, and 20% for bonds not eligible for TRACE reporting, suggesting the presence of a “liquidity externality.” The key results are robust to changes in variables, such as interest rate volatility and trading activity that might also affect execution costs. Market shares and the cost advantage to large dealers decreased post-TRACE. These results indicate that market design can have first-order effects, even for sophisticated institutional customers.     

Explaining green bond issuance using survey evidence: Beyond the greenium

The paper examines the drivers and challenges of issuing green bonds from the perspective of green bond issuers. Using survey evidence of global issuers representing 29% of total green bond issuances, the research shows that reputational benefits, the market signalling power of green bonds and a desire to curb climate change are the main motives for green bond issuance. In contrast, insufficient market evolvement, and a lack of awareness and suitable green projects represent the biggest barriers for entry to the green bond market. Most respondents consider green bond issuance costs to be higher than those of comparable plain vanilla bonds, but acceptable due to the benefits they derive from green bond issuances. Among these benefits, respondents report higher levels of demand for green bonds, higher levels of investor engagement, diversification of their investor base and a strengthened internal commitment to sustainability. Issuers' experiences vary regarding the pricing of green bonds – with 48% of respondents stating that their green bond funding costs are the same as for their plain vanilla bonds and 42% reporting lower green bond funding costs. Most issuers favour a standardisation of the definition of ‘green’ for determining which projects can be funded via green bonds.     

透明度变化对股票市场投资者委托单提交行为和交易成本影响研究

基于2003年12月8日沪深交易所交易前市场透明度改革背景,本文利用一家营业部的投资者报价和交易数据,研究同一个机构投资者和散户投资者在透明度改革前后委托单提交激进程度的变化,以及这种变化对其完成交易的成本的影响。我们发现,透明度改革前后,机构投资者的委托单提交激进程度都显著大于散户投资者的委托单提交激进程度。透明度增加以后,机构投资者的委托单激进程度显著减少,而散户投资者的委托单提交激进程度增加。同时发现,透明度增加以后,机构投资者通过分拆委托单,增加交易次数,导致完成交易的时间增加,但价格影响力基本没有变化,散户投资者的成交时间和价格影响力有显著改善。     

THE COST OF INCLUDING A CALL PROVISION IN MUNICIPAL DEBT CONTRACTS

Municipal bond market studies testing for the effect of a call provision on new-issue borrowing cost fail to examine if the cost of the call provision is sensitive to expected changes in interest rates. This may explain why some studies find that the presence of a call provision increases municipal borrowing costs while others find no effect. Another possible reason for the contradictory findings may be a failure to correct for a self-selection bias that results when some issuers choose to include a call provision and others do not. To correct for the potential self-selection problem, a two-stage probit switching regression technique is used here to estimate the cost of a call provision to municipal issuers. Results indicate municipal issuers pay a premium for the call privilege at the time of issue and that the size of the premium is sensitive to expected changes in interest rates.     

Transparency and Liquidity: A Controlled Experiment on Corporate Bonds

This article reports the results of an experiment designed toassess the impact of last-sale trade reporting on the liquidityof BBB corporate bonds. Overall, adding transparency has eithera neutral or a positive effect on liquidity. Increased transparencyis not associated with greater trading volume. Except for verylarge trades, spreads on newly transparent bonds decline relativeto bonds that experience no transparency change. However, wefind no effect on spreads for very infrequently traded bonds.The observed decrease in transaction costs is consistent withinvestors’ ability to negotiate better terms of tradeonce they have access to broader bond-pricing data. (JEL codes:G14, G18, G23, G24, G28)     

Permanent trading impacts and bond yields

We analyse four years of transaction data for euro-area sovereign bonds traded on the MTS electronic platforms. In order to measure the informational content of trading activity, we estimate the permanent price response to trades. We not only find strong evidence of information asymmetry in sovereign bond markets, but also show the relevance of information asymmetry in explaining the cross-sectional variations of bond yields across a wide range of bond maturities and countries. Our results confirm that trades of more recently issued bonds and longer maturity bonds have a greater permanent effect on prices. We compare the price impact of trades for bonds across different maturity categories and find that trades of French and German bonds have the highest long-term price impact in the short maturity class, whereas trades of German bonds have the highest permanent price impact in the long maturity class. More importantly, we study the cross-section of bond yields and find that after controlling for conventional factors, investors demand higher yields for bonds with larger permanent trading impact. Interestingly, when investors face increased market uncertainty, they require even higher compensation for information asymmetry.     

On short-term institutional trading skill,behavioral biases,and liquidity need

Are portfolio managers skilled or do they trade too much? Using a marked-to-market based “fair-value” method for measuring fund manager skill, we find that institutional managers can potentially earn +42 (+33) basis points benchmark-adjusted return before transaction costs after a holding period of four weeks on their buy (sell) trades. After transaction costs, the benchmark-adjusted return for the buy (sell) trades is +1 (-8) basis points. Pension fund managers outperform money managers. We are unable to detect evidence for overconfidence among pension fund managers over this short-horizon. In addition, we are unable to find evidence of disposition effect among mutual fund managers. Institutions tend to engage in short-term trades with holding period of four weeks (or less) despite only breaking-even or making economically insignificant (modest) benchmark-adjusted losses after round-trip transaction costs for liquidity, risk-management, or tax-minimization reasons. Among these, evidence for liquidity trading motive is the strongest.