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TRACE Independent Academic Studies

Scholars have published several papers that evaluate TRACE's impact on liquidity, valuation and other aspects of the U.S. Corporate Bond market. Abstracts and links to the studies are listed below.

Receiving Investors in the Block Market for Corporate Bonds

by Stacey Jacobsen a, Kumar Venkataraman a
November 1, 2023

Using the enhanced Trade Reporting and Compliance Engine (TRACE) data, this research examines block trading in corporate bonds to test theoretical predictions regarding receiving investors to whom dealers distribute the block. By exploiting rules governing trade reporting timeliness and using proxies for informed trading, this research show that receivers experience worse outcomes in settings with elevated information asymmetry, although losses are smaller than initiating a similar-size trade. Receivers obtain better terms in periods following mandatory trade reporting and for offsetting trades that occur after block trade disclosure. Dealers speed up offsetting activity with shorter reporting delay, but do not withdraw. This study highlights the relevance of disclosure rules and conditions for a well-functioning block market.

Life after Default: Dealer Intermediation and Recovery in Defaulted Corporate Bonds

by Baumann, Friedrich and Kakhbod, Ali and Livdan, Dmitry and Nazemi, Abdolreza and Schuerhoff, Norman,
September 22, 2023

The research examines the trading and pricing of defaulted U.S. corporate bonds. Defaulted bonds are actively traded since the bonds’ natural holders change from buy-and-hold to specialized vulture investors. This research document that intermediation after default shifts to dealers with prior expertise in the defaulted bond. These primary dealers locate higher-valuation counterparties in longer intermediation chains and absorb more order flow in their inventory than other dealers. The switch to trading with primary dealers raises recovery rates by 8%. The research results highlight the importance of dealers’ expertise in intermediating specific corporate bonds which stabilizes market functioning and lowers credit risk ex-ante.

Flight from Liquidity and Corporate Bond Yields

by Ali Ebrahim Nejad, Saeid Hoseinzade, Aryan Molanei
July 31, 2023

This paper documents that in distress periods, liquidity constrained investors sell liquid corporate bonds and hold onto illiquid ones, a phenomenon which we refer to as flight from liquidity. Performing within issuer-time analysis to properly control for credit risk, we find that flight from liquidity results in a decline in the liquidity premium. In other words, liquid bonds that are significantly more expensive in normal market conditions, lose more value in distress periods and trade at a closer, and sometimes at an indistinguishable, yield spread to their illiquid peers from the same issuer. The paper also find that these shocks to the liquidity premium are short-lived and do not have a long-lasting pricing impact.

We provide suggestive evidence that the liquidity clientele effect derives these results. Our findings suggest that investment exposure to liquid bonds entails a unique risk arising during periods of distress.

The anatomy of corporate securitizations and contract design.

by Shohini Kundu
July 20, 2023

Collateralized loan obligations (CLOs), intermediaries situated between investors and traditional banks, play an increasingly central role in the provision of credit to constrained corporations, holding as much as 75% of all new institutional leveraged loans. Despite their ascendancy in the risky corporate credit market, there has been little academic research on the CLO market. This paper provides a comprehensive overview of the design and structure of the CLO market, describing the general macroeconomic milieu that has facilitated the rapid growth of the market, the mechanics therein, as well as recent risks that have emerged. Understanding the anatomy and dynamics of CLOs is paramount for developing insights into the role of non-bank financial intermediaries in financial markets.

Bond Market Transparency and Stock Price Crash Risk: Evidence from a Natural Experiment

by Yuyan Guan, Jeong-Bon Kim, Boluo Liu, Xiangang Xin.
July 1, 2023

Utilizing the Trade Reporting and Compliance Engine (TRACE) setting as an exogenous shock to bond market transparency, we find that improved bond market transparency leads to lower crash risk in the stock market, consistent with increased information spillover from the bond market into the stock market. Results from the Path analysis suggest that bond market transparency affects stock price crash risk not only directly, but also indirectly through its effects on management guidance, analyst forecasts, and media reports. We also find that the mitigation effect of bond market transparency on stock price crash risk is more pronounced for firms with higher default risk bonds, lower institutional stock ownership, and more opaque financial reporting. Overall, our findings suggest that increased bond market transparency following TRACE generates a positive externality in reducing crash risk in the stock market.

Trade Transparency and Management Earnings Forecasts

by Deniz Anginer (Simon Fraser University), Stephen P. Baginski (University of Georgia - J.M. Tull School of Accounting), Snow (Xue) Han (San Francisco State University), Çelim Yıldızhan (Koç University).
Posted: 29 Apr 2021 - Last revised: 16 Apr 2023

Employing a plausibly exogenous shock that increased the extent to which private information is revealed in debt markets – the implementation of the Trade Reporting and Compliance Engine (TRACE) - we document a change in long-run management earnings forecast policy. We find that managers decreased their forecast frequency over the three-year period post-TRACE. The decline was greater for bad news management earnings forecasts, when the pre-disclosure information environment was weaker, and for firms closer to credit default. These findings, taken in conjunction with prior findings of increases in earnings forecasting activity in response to declines in the strength of the information environment, suggest that the inverse relationship between changes in the strength of the information environment and management earnings forecasting activity is symmetrical. Our results also suggest that prior research understates the informational benefits of TRACE because of the decline in management earnings forecasting pursuant to TRACE.

Dealer Networks and the Cost of Immediacy*

By Jens Dick-Nielsen (Copenhagen Business School – Department of Finance), Thomas K. Poulsen (BI Norwegian Business School), Obaidur Rehman (BI Norwegian Business School)

Posted: 19 Feb 2021 – Last revised: 4 Jan 2023

Using bonds transactions data from Academic TRACE this research examine how dealer network position affects transaction costs when dealers provide immediacy by taking bonds into inventory. Dealers with central network positions provide more immediacy and revert deviations from their desired inventory faster than peripheral dealers do. The cost of immediacy decreases with centrality for customer trades (centrality discount) and increases with centrality for interdealer trades (centrality premium). These findings support recent network models in which central dealers have a comparative advantage in managing inventory. We isolate the inventory management channel and avoid confounding effects from adverse selection and heterogeneous customer clienteles by using trades around bond index exclusions.

Portfolio Trading in Corporate Bond Markets

by Jeffrey Meli (Barclays), Zornitsa Todorova (Barclays)
December 11, 2022

Portfolio trading, a recent innovation in the corporate bond market, involves trading a basket of bonds as a single piece of risk with a single market-maker. Using a proprietary dataset of portfolio inquiries, we train a machine learning algorithm to identify portfolio trades in TRACE. Using this novel dataset, we estimate that portfolio trading has increased from 0% at the beginning of 2018 to over 7% of total volumes in 2021. Investors mainly use this new protocol to “crowd-source” liquidity for a set of very illiquid bonds by packaging them with highly liquid bonds. Portfolio trading reduces execution costs by over 40%, with the largest benefits accruing to illiquid bonds. We provide evidence that spillovers from the ETF ecosystem allow market-makers to hedge risk and to offload the inventory of illiquid bonds which accumulates as a result of portfolio trading.

The Effect of Market Transparency on Corporate Disclosure

By Georg Rickmann (Northwestern University - Kellogg School of Management)
Last revised: May 17, 2021

Observable market prices and trading are important information constructs that reveal information to market participants. I study how the observability of market prices and trading (hereafter, “market transparency”) affects firms’ disclosure incentives. I exploit the staggered introduction of TRACE, which made bond prices and transactions publicly observable. I find that firms provide more guidance when their bonds’ prices/trading become observable, suggesting that investors’ access to market information limits managers’ incentives to withhold information. This effect is stronger for firms whose revealed prices contain more new information, and it is more pronounced for the disclosure of bad news. I corroborate my results using (i) a controlled experiment, in which prices/trading were revealed for randomly selected bonds, and also (ii) relevant threshold rules. Together, my results suggest that increased market transparency improves investors’ access to information not only directly, by revealing the information contained in returns/trading, but also indirectly, by increasing corporate disclosure.

Capital Commitment and Illiquidity in Corporate Bonds

by Hendrik Bessembinder, Stacey E. Jacobsen, William F. Maxwell, Kumar Venkataraman
July 20, 2016

We study liquidity in U.S. corporate bond markets from 2003 to 2014. Despite a temporary increase during the financial crisis, trade execution costs have decreased over time. However, alternative measures, including intraday and overnight dealer capital commitment, dealer participation as principals, turnover, the frequency of block trades, and interdealer trading, have not returned to pre-crisis levels and in many cases have worsened. The reduction in dealers’ commitment to bond market making in recent years is attributable to bank-affiliated dealers, while non-bank dealers have increased their participation. The evidence supports that these outcomes reflect unintended consequences of post-crisis regulations focused on banking.

Introducing Daylight to Structured Credit Products

by Bessembinder, Hendrik, Maxwell, William and Venkataraman, Kumar
November 26, 2012

Structured Products, including asset-backed and mortgage-backed securities, comprise one of the fastest growing areas in the financial services industry. By the end of 2011, there was $8.4 trillion outstanding in mortgage-backed securities and $1.8 trillion outstanding in asset-backed securities (in comparison, $10.6 trillion in Treasuries were outstanding). Structured products comprise a significant component of asset allocations in institutional portfolios and the uncertainty associated with their valuation played an important role in the transmission of shocks during the recent financial crisis. Although these securities are of central importance to financial markets, the secondary market for Structured Products is non-transparent, characterized by an absence of either public quotations or public reports of transaction prices and quantities. Additionally, Structured Products are unique in their characteristics and customer profiles. Structured Products can be extremely complex financial instruments with multiple tranches and different payout and risk structures. These products are typically issued by investment banks or their affiliates, and many of the products are targeted to retail investors and private bank clients. The goal of this paper is to provide a first systematic look at the inner working of the secondary market in Structured Products and to the extent possible compare the Structured Products to the corporate bond market to provide implications for market participants when post-trade price reporting is introduced in structured credit products.

Liquidity, Transparency and Disclosure in the Securitized Product Market 

by Friewald, Nils, Jankowitsch, Rainer and Subrahmanyam, Marti G.
August 31, 2012

We analyze liquidity effects in the US fixed-income securitized product market using a unique data-set compiled by the Financial Industry Regulatory Authority (FINRA), containing all transactions between May 16, 2011 and February 29, 2012. We employ a wide range of liquidity proxies proposed in the academic literature that rely on various information sets. Our results show that the average transaction cost of a round-trip trade is around 66 basis points in the securitized product market and that liquidity is quite diverse in the different market segments. In particular, we find that securities that are mainly institutionally traded, issued by a federal authority, or with low credit risk, tend to be more liquid. In addition, we discuss the relation between the measurement of liquidity and the disclosure of information, and provide evidence that transaction cost measures computed at a more aggregate level may still be reasonable proxies for liquidity. This finding is important for all market participants, but particularly for regulators, who need to decide on the level of detail of the transaction data to be disseminated to the market.

Liquidity and Value in the Deep vs. Shallow Ends of Mortgage-Backed Securities Pools

by Atanasov, Vladimir A. and Merrick, John J.
August 3, 2012

We use new TRACE data to study trade-size segmentation in liquidity and pricing of agency MBS. Market rules give institutional (retail) MBS trader's easy (hard) access to a liquid To-Be-Announced (TBA) forward market. We show that TBA access translates into enhanced liquidity with bid-ask spreads of less than 0.1% for large MBS trades versus 1% for small trades. We exploit this unique trade-specific variation in liquidity to generate new estimates of liquidity impacts on prices. We compare the pricing of small and large trades in the same security and conclude that small trade illiquidity causes 1% to 5% price discounts.

Liquidity of Corporate Bonds

by Bao, Jack, Pan, Jun and Wang, Jiang
July 9, 2008

This paper examines the liquidity of corporate bonds and its asset-pricing implications using a novel measure of illiquidity based on the magnitude of transitory price movements. Using transaction-level data for a broad cross-section of corporate bonds from 2003 through 2007, we find the illiquidity in corporate bonds to be significant, substantially greater than what can be explained by bid-ask bounce, and closely linked to liquidity-related bond characteristics. More importantly, we find a strong commonality in the time variation of bond illiquidity, which rises sharply during market crises and reaches an all-time high during the recent sub-prime mortgage crisis. Monthly changes in this aggregate bond illiquidity are strongly related to changes in the CBOE VIX Index and lagged stock market returns. Examining its relation with bond pricing, we find that our measure of illiquidity explains the cross-sectional variation in average bond yield spreads with large economic significance.

Missing the Marks: Dispersion in Corporate Bond Valuations Across Mutual Funds

by Cici, Gjergji , Gibson, Scott and Merrick, John J.
first draft November 2007
second draft May 2008

We study the dispersion of month-end valuations placed on identical corporate bonds by different mutual funds. Our dispersion measures offer insights into corporate bond valuation problems at the individual security level. Results show that pricing dispersion is related to bond-specific characteristics typically associated with market liquidity and market-wide volatility. We show that the rollout of FINRA's transparency-enhancing TRACE system has increased the precision of corporate bond valuation, benefiting investors. We also find that the volatile marking patterns of some funds are associated with return smoothing behavior. However, return smoothing behavior is not prevalent across our sample of bond mutual funds.

Price Dispersion in OTC Markets: A New Measure of Liquidity

by Jankowitsch, Rainer, Nashikkar, Amrut J. and Subrahmanyam, Marti G.
April 2008

In this paper, we model price dispersion effects in over-the-counter (OTC) markets to show that in the presence of inventory risk for dealers and search costs for investors, traded prices may deviate from the expected market valuation of an asset. We interpret this deviation as a liquidity effect and develop a new liquidity measure quantifying the price dispersion in the context of the US corporate bond market. This market offers a unique opportunity to study liquidity effects since, from October 2004 onwards, all OTC transactions in this market have to be reported to a common database known as the Trade Reporting and Compliance Engine (TRACE). Furthermore, market-wide average price quotes are available from Markit Group Limited, a financial information provider. Thus, it is possible, for the first time, to directly observe deviations between transaction prices and the expected market valuation of securities. We quantify and analyze our new liquidity measure for this market and find significant price dispersion effects that cannot be simply captured by bid-ask spreads. We show that our new measure is indeed related to liquidity by regressing it on commonly-used liquidity proxies and find a strong relation between our proposed liquidity measure and bond characteristics, as well as trading activity variables. Furthermore, we evaluate the reliability of end-of-day marks that traders use to value their positions. Our evidence suggests that the price deviations are significantly larger and more volatile than previously assumed. Overall, the results presented here improve our understanding of the drivers of liquidity and are important for many applications in OTC markets, in general.

Transparency and the Corporate Bond Market

by Maxwell, William F. and Bessembinder, Hendrik (Hank)
January 10, 2008

The U.S. corporate bond market underwent a fundamental change with the introduction of TRACE in 2002. Beginning on that date, bond dealers were required to report all trades in publicly-issued corporate bonds to the National Association of Security Dealers, which in turn made transaction data available to the public. In this paper, we assess the impact of the increase in transparency on the corporate bond market. Investors have benefited from the increased transparency, through substantial reductions in the bid-ask spreads that they pay to bond dealers to complete trades. Conversely, bond dealers have experienced reductions in employment and compensation, and dealers' trading activities have moved toward alternate securities, including syndicated bank loans and credit default swaps. The primary complaint against TRACE is that trading is more difficult as dealers are reluctant to carry inventory and no longer share the results of their research. In essence, the cost of trading corporate bonds decreased, but so did the quality and quantity of the services formerly provided by bond dealers. The debate regarding optimal transparency of the corporate bond markets continues, and the question of what degree of transparency in security markets is desirable will remain the subject of study and debate for the foreseeable future.

Market Transparency, Liquidity Externalities, and Institutional Trading Costs in Corporate Bonds

by Bessembinder, Hendrik (Hank), Maxwell, William F. and Venkataraman, Kumar
November 2005

We develop a simple model of the effect of transaction reporting on trade execution costs and test it using a sample of institutional trades in corporate bonds, before and after the initiation of public transaction reporting through the TRACE system. The results indicate a reduction of approximately 50% in trade execution costs for bonds eligible for TRACE transaction reporting, and consistent with the model's implications, also indicate the presence of a "liquidity externality" that results in a 20% reduction in execution costs for bonds not eligible for TRACE reporting. The key results are robust to allowances for changes in variables, such as interest rate volatility and trading activity, which might also affect execution costs. We also document decreased market shares for large dealers and a smaller cost advantage to large dealers post-TRACE, suggesting that the corporate bond market has become more competitive after TRACE implementation. These results reinforce that market design can have first-order effects, even for sophisticated institutional customers.

Transparency and Liquidity: A Controlled Experiment on Corporate Bonds

by Goldstein, Michael A., Hotchkiss, Edith S. and Sirri, Erik R
March 20, 2006
first draft November 1, 2004

This article reports the results of an experiment designed to assess the impact of last-sale trade reporting on the liquidity of BBB corporate bonds. Overall, adding transparency has either a neutral or a positive effect on liquidity. Increased transparency is not associated with greater trading volume. Except for very large trades, spreads on newly transparent bonds decline relative to bonds that experience no transparency change. However, we find no effect on spreads for very infrequently traded bonds. The observed decrease in transactions costs is consistent with investors' ability to negotiate better terms of trade once they have access to broader bond-pricing data.

Corporate Bond Market Transparency and Transaction Costs

by Edwards, Amy K., Harris, Lawrence and Piwowar, Michael S
September 21, 2004

Using TRACE data—a complete record of all US OTC secondary trades in corporate bonds—we estimate average transaction cost as a function of trade size for each bond that traded more than nine times in 2003. We find that transaction costs are higher than in equities and decrease significantly with trade size. Highly rated bonds, recently issued bonds, and bonds that will soon mature have lower transaction costs than do other bonds. Costs are lower for bonds with publicly disseminated trade prices, and they drop when the TRACE system starts to publicly disseminate their prices. The results suggest that public traders would significantly benefit if bond prices were made more transparent.