We document a pecking order of transaction costs in the interdealer market for German sovereign bonds, where three trading protocols coexist. Dealers can trade over the counter (OTC), either bilaterally or via brokers, as well as on an exchange. Trading on the exchange is more expensive than OTC, and broker-intermediated trades are more costly than bilateral OTC trades. The existence of an OTC discount is difficult to square with theories centered around search-and-bargaining frictions but is in line with models of hybrid markets based on information frictions. Consistently, we show that dealers’ information impacts their choice of trading protocol and that the pecking order of transaction costs is aligned with the informational content of order flows across protocols. Search and bargaining as well as information proxies explain differences in OTC discount within protocols. A realistic description of hybrid markets thus requires both types of frictions. This paper was accepted by Agostino Capponi, finance. Funding: L. Pelizzon and M. Schneider acknowledge funding by the Deutsche Forschungsgemeinschaft Grant 329107530. L. Pelizzon thanks the Leibniz Institute for Financial Research SAFE for financially sponsoring this research. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2022.00194 .
Roure et al. (Tue,) studied this question.