The Effects of Transparency on OTC Market-Making

49 Pages Posted: 12 Dec 2018 Last revised: 12 Aug 2021

See all articles by Ryan Lewis

Ryan Lewis

University of Colorado, Boulder

Michael Schwert

University of Pennsylvania - The Wharton School

Date Written: April 5, 2021

Abstract

We examine the effects of post-trade transparency on intermediation in the over-the-counter corporate bond market using the staggered introduction of TRACE as a natural experiment. Post-trade transparency leads to increased trading volume and more connected dealer networks. Transparency reduces dealers' profitability but also their portfolio risk and adverse selection costs. In contrast to prior research suggesting that TRACE benefits customers at the expense of dealers, we show that the net effect on dealer welfare is ambiguous. Bond spreads are less predictive of default in a transparent market, consistent with reduced profitability of informed trade weakening incentives to produce information.

Keywords: over-the-counter markets, price transparency, corporate bonds

JEL Classification: G12, G14, G23

Suggested Citation

Lewis, Ryan and Schwert, Michael, The Effects of Transparency on OTC Market-Making (April 5, 2021). Jacobs Levy Equity Management Center for Quantitative Financial Research Paper , Available at SSRN: https://ssrn.com/abstract=3286731 or http://dx.doi.org/10.2139/ssrn.3286731

Ryan Lewis

University of Colorado, Boulder ( email )

Boulder, CO 80309-0419
United States

Michael Schwert (Contact Author)

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

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