An Empirical Study of Bond Market Transactions

Short histories of dealer-market and exchange-based bond transactions in machine-readable form have recently become available. They permitted us to provide for the first time direct estimation of the effective bid-ask spread for corporate bonds in the institutional and retail markets. Overall, we found effective spreads for NYSE-traded corporate bonds to be similar to effective spreads for dealer-market transactions. Evidence is that corporate bond spreads have declined over time and that dealers carry out U.S. government bond trades with major institutional clients as a nonprofit service, perhaps to support other (ostensibly) profitable activities. We demonstrate that bid-ask spreads and the magnitude of price discrepancies between data sources are reliably associated with proxies for risk and liquidity.