Size Effects in the Pricing of Corporate Bonds

Authors

  • Padma Kadiyala,

    Corresponding author
    • Corresponding author: Padma Kadiyala, Department of Finance and Economics, Lubin School of Business, Pace University, 861 Bedford Road, Pleasantville, NY 10570. Tel: (914) 773 3620, Fax: (914) 773 3920. Email: pkadiyala@pace.edu.

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  • P.V. Viswanath


Abstract

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.

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