Size Effects in the Pricing of Corporate Bonds
Article first published online: 16 OCT 2013
© 2013 New York University Salomon Center and Wiley Periodicals, Inc.
Financial Markets, Institutions & Instruments
Volume 22, Issue 4, pages 229–258, November 2013
How to Cite
Kadiyala, P. and Viswanath, P.V. (2013), Size Effects in the Pricing of Corporate Bonds. Financial Markets, Institutions & Instruments, 22: 229–258. doi: 10.1111/fmii.12011
- Issue published online: 16 OCT 2013
- Article first published online: 16 OCT 2013
Large orders for corporate bonds get preferential treatment unlike large orders for stocks on the NYSE. A structural explanation, namely, that the corporate bond market is dealer-dominated, has been offered for the favorable pricing. In this paper, we offer an additional explanation, namely, that the improved pricing for large orders is due to the net impact such orders have on a market maker's costs. Using a data sample that is substantially free of timing mismatch, we support our assertion by sorting the sample into ‘brokered’ trades, which are trades where the dealer merely crosses buy and sell orders and ‘inventoried’ trades, where the dealer trades out of his inventory. We find that large orders raise information costs, but lower inventory costs for ‘inventoried’ trades. The net result is a smaller price advantage than received by large orders on ‘brokered’ trades which are not subject to these costs.