TY - JOUR
T1 - Customer Liquidity Provision
T2 - Implications for Corporate Bond Transaction Costs
AU - Choi, Jaewon
AU - Huh, Yesol
AU - Shin, Sean Seunghun
N1 - The authors are grateful to Scott Bauguess, Andrew Chen, Darrell Duffie, Larry Harris, Erik Heitfield, Terrence Hendershott, Edith Hotchkiss, Stacey Jacobsen, Yoshio Nozawa, Elvira Solji, Clara Vega, and Brian Weller as well as conference and seminar participants at the Bank of Canada, the Commodity Futures Trading Commission, the Securities and Exchange Commission, 2017 China International Conference in Finance, the 2017 European Finance Association Annual Meeting, the 2018 American Finance Association Annual Meeting, the Workshop on Investor Behavior and Market Liquidity, and the Women in Microstructure Meeting for their comments and discussions. The authors also thank Will Kuchinski and Darrell Ashton for providing code for cleaning the TRACE data. Earlier drafts of this paper have circulated under the title “Customer Liquidity Provision in Corporate Bond Markets.” The views expressed in this article are solely those of the authors and should not be interpreted as reflecting the views of the Federal Reserve Board or the Federal Reserve System.
PY - 2024/1
Y1 - 2024/1
N2 - The convention when calculating corporate bond trading costs is to estimate bid–ask spreads that customers pay, implicitly assuming that dealers always provide liquidity to customers. We show that, contrary to this assumption, customers increasingly provide liquidity following the adoption of post-2008 banking regulations, and thus, conventional bid–ask spread measures underestimate the cost of dealers’ liquidity provision. Among large trades wherein dealers use inventory capacity, customers pay 40%–60% wider spreads than before the crisis. Customers’ balance-sheet capacity and their trading relationships with dealers are important determinants of customer liquidity provision.
AB - The convention when calculating corporate bond trading costs is to estimate bid–ask spreads that customers pay, implicitly assuming that dealers always provide liquidity to customers. We show that, contrary to this assumption, customers increasingly provide liquidity following the adoption of post-2008 banking regulations, and thus, conventional bid–ask spread measures underestimate the cost of dealers’ liquidity provision. Among large trades wherein dealers use inventory capacity, customers pay 40%–60% wider spreads than before the crisis. Customers’ balance-sheet capacity and their trading relationships with dealers are important determinants of customer liquidity provision.
KW - bank regulations and OTC liquidity
KW - corporate bond liquidity
KW - customer liquidity provision
KW - insurer liquidity provision
UR - http://www.scopus.com/inward/record.url?scp=85182276510&partnerID=8YFLogxK
UR - http://www.scopus.com/inward/citedby.url?scp=85182276510&partnerID=8YFLogxK
U2 - 10.1287/mnsc.2022.4646
DO - 10.1287/mnsc.2022.4646
M3 - Article
AN - SCOPUS:85182276510
SN - 0025-1909
VL - 70
SP - 187
EP - 206
JO - Management Science
JF - Management Science
IS - 1
ER -