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Please use this identifier to cite or link to this item:
http://hdl.handle.net/2451/27855
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| Title: | Price Dispersion in OTC Markets: A New Measure of Liquidity |
| Authors: | Subrahmanyam, Marti
Nashikkar, Amrut
Jankowitsch, Rainer |
| Issue Date: | 2-Feb-2009 |
| Series/Report no.: | FIN-08-013 |
| Abstract: | 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 from expected market valuations 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. |
| URI: | http://hdl.handle.net/2451/27855 |
| Appears in Collections: | Finance Working Papers
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