Top Banner
1 A Tale of Two Platforms: Dealer Intermediation in the European Sovereign Bond Market CEPR Discussion Paper 6969 http://www.haraldhau.com Peter Dunne, Central Bank of Ireland Harald Hau, INSEAD Michael Moore, Queen’s University, Belfast
26

1 A Tale of Two Platforms: Dealer Intermediation in the European Sovereign Bond Market CEPR Discussion Paper 6969 Peter Dunne,

Mar 26, 2015

Download

Documents

Avery Malone
Welcome message from author
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
Page 1: 1 A Tale of Two Platforms: Dealer Intermediation in the European Sovereign Bond Market CEPR Discussion Paper 6969  Peter Dunne,

1

A Tale of Two Platforms:

Dealer Intermediation in the European Sovereign Bond Market

CEPR Discussion Paper 6969

http://www.haraldhau.com

Peter Dunne, Central Bank of Ireland

Harald Hau, INSEAD

Michael Moore, Queen’s University, Belfast

Page 2: 1 A Tale of Two Platforms: Dealer Intermediation in the European Sovereign Bond Market CEPR Discussion Paper 6969  Peter Dunne,

© Harald Hau, INSEAD 2

Motivation

Dual Market Structures: Interdealer Market (B2B): Dealer Segment Wholesale Market (B2C): Customer Segment

Market Quality? Customer segment is under-researched, but very important Interaction studies even more rarely

Why is it interesting? Regulatory policy issues: Should we allow a dual market? Do

customers get good market quality? When? Dealer activity is intermediation between two markets; hence

want to model and understand interaction between markets

Page 3: 1 A Tale of Two Platforms: Dealer Intermediation in the European Sovereign Bond Market CEPR Discussion Paper 6969  Peter Dunne,

© Harald Hau, INSEAD 3

Dealer Intermediation

Dealer 1

Dealer 3

Dealer 2

CustomersB2B

B2C

Page 4: 1 A Tale of Two Platforms: Dealer Intermediation in the European Sovereign Bond Market CEPR Discussion Paper 6969  Peter Dunne,

© Harald Hau, INSEAD 4

Three Research Questions

What is the average market quality in the B2C segment?

How big is the dispersion of B2C quotes and what determines B2C execution quality?

How does relative market quality vary with market conditions (volatility)?

Page 5: 1 A Tale of Two Platforms: Dealer Intermediation in the European Sovereign Bond Market CEPR Discussion Paper 6969  Peter Dunne,

© Harald Hau, INSEAD 5

Related Research

U.S. municipal bond market: Harris and Piwowar (2006) Green, Hollifield and Schurhoff (2007)

Market quality Low average execution quality Large dispersion of transaction prices (= price discrimination?)

Why? Unsophisticated retail clients make trading errors No price transparency

European Sovereign bond market: Small banks and institutions are customers …. not retail clients

Page 6: 1 A Tale of Two Platforms: Dealer Intermediation in the European Sovereign Bond Market CEPR Discussion Paper 6969  Peter Dunne,

© Harald Hau, INSEAD 6

Key Findings for European Sovereign Bond Market

B2C transactions show high quality: They are on average better than the best interdealer quotes.

This extends to non-benchmark bonds.

B2C transaction show high quality dispersion Best and worst quartile averages differ by 4.56 (5.33) cents on

the ask (bid) side relative to an average B2B spread of 4.31

More (or constant) relative B2C quality under more risk (adverse selection)

Page 7: 1 A Tale of Two Platforms: Dealer Intermediation in the European Sovereign Bond Market CEPR Discussion Paper 6969  Peter Dunne,

© Harald Hau, INSEAD 7

Our Data

Dealer to Dealer (B2B) data from MTS for 3 quarters in 2005

1,369 billion Euros in volume 188,782 trades

Matched data from the MTS customer trading platform BondVision

240 billion Euros in volume 45,504 trades

Focus: Italian benchmark bonds (= best data coverage)

Page 8: 1 A Tale of Two Platforms: Dealer Intermediation in the European Sovereign Bond Market CEPR Discussion Paper 6969  Peter Dunne,

© Harald Hau, INSEAD 8

Summary on Market

Page 9: 1 A Tale of Two Platforms: Dealer Intermediation in the European Sovereign Bond Market CEPR Discussion Paper 6969  Peter Dunne,

© Harald Hau, INSEAD 9

Italian/Non-Italian B2B and B2C Segment

Italian Benchmark Bonds

Page 10: 1 A Tale of Two Platforms: Dealer Intermediation in the European Sovereign Bond Market CEPR Discussion Paper 6969  Peter Dunne,

© Harald Hau, INSEAD 10

Measuring B2C Transaction Quality

Cross-market spread: Positive measure of price improvement of B2C transaction over best B2B quote on the same side of the market

Page 11: 1 A Tale of Two Platforms: Dealer Intermediation in the European Sovereign Bond Market CEPR Discussion Paper 6969  Peter Dunne,

© Harald Hau, INSEAD 11

Cross-market Spreads by Bond Type

Bid side B2C quality

dispersion: 3.35 centsAv. B2B Spread: 1.82 cents

Page 12: 1 A Tale of Two Platforms: Dealer Intermediation in the European Sovereign Bond Market CEPR Discussion Paper 6969  Peter Dunne,

© Harald Hau, INSEAD 12

Cross-Market Spreads by Maturity

Page 13: 1 A Tale of Two Platforms: Dealer Intermediation in the European Sovereign Bond Market CEPR Discussion Paper 6969  Peter Dunne,

© Harald Hau, INSEAD 13

Cross-Market Spreads by Volatility

Page 14: 1 A Tale of Two Platforms: Dealer Intermediation in the European Sovereign Bond Market CEPR Discussion Paper 6969  Peter Dunne,

© Harald Hau, INSEAD 14

Model of Dealer Intermediation

Dealers have monopolistic customer (B2C) relationships and are allowed to have inventories of -1,0,+1

Customers arrive stochastically for a transaction quantity of +1 (or -1) with uniform reservation price distribution above (below) the stochastic value xt for the bid (ask) price. Innovations Δxt are binomial in each trading round.

Dealers have to rebalance in the B2B market immediately if their holdings are above +1 or below -1. The B2B market is competitive and there is always at least one dealers with opposite holding to rebalance.

Page 15: 1 A Tale of Two Platforms: Dealer Intermediation in the European Sovereign Bond Market CEPR Discussion Paper 6969  Peter Dunne,

© Harald Hau, INSEAD 15

Trading Sequence

Page 16: 1 A Tale of Two Platforms: Dealer Intermediation in the European Sovereign Bond Market CEPR Discussion Paper 6969  Peter Dunne,

© Harald Hau, INSEAD 16

Dealer Problem

Page 17: 1 A Tale of Two Platforms: Dealer Intermediation in the European Sovereign Bond Market CEPR Discussion Paper 6969  Peter Dunne,

© Harald Hau, INSEAD 17

Value Function

Page 18: 1 A Tale of Two Platforms: Dealer Intermediation in the European Sovereign Bond Market CEPR Discussion Paper 6969  Peter Dunne,

© Harald Hau, INSEAD 18

Optimal B2C Quotes Relative to xt

Ask (bid) side B2C prices are improved under positive (negative) dealer inventory

Selling your positive inventory to customers is an advantageous way to rebalance

Page 19: 1 A Tale of Two Platforms: Dealer Intermediation in the European Sovereign Bond Market CEPR Discussion Paper 6969  Peter Dunne,

© Harald Hau, INSEAD 19

B2B Equilibrium Condition

B2B price is such that the dealer (with the opposite inventory balance) is indifferent between being hit or not

The adverse selection risk from B2B quote provision is

Page 20: 1 A Tale of Two Platforms: Dealer Intermediation in the European Sovereign Bond Market CEPR Discussion Paper 6969  Peter Dunne,

© Harald Hau, INSEAD 20

Existence of a Stable Equilibrium in B2B and B2C

B2C: Higher B2B speads inventory constrains more costly

Convexity of value function larger

B2B: Higher B2B spreads Come with more adverse

selection loss in B2B High value convexity makes B2B

submission more attractive

Page 21: 1 A Tale of Two Platforms: Dealer Intermediation in the European Sovereign Bond Market CEPR Discussion Paper 6969  Peter Dunne,

© Harald Hau, INSEAD 21

Cross Market Spread and Volatility

Relative B2C market quality increase with higher risk

Page 22: 1 A Tale of Two Platforms: Dealer Intermediation in the European Sovereign Bond Market CEPR Discussion Paper 6969  Peter Dunne,

© Harald Hau, INSEAD 22

Aggregate Imbalances

Would like to estimate model on dealer inventory balances, but not these are not available

Model: Know that dealers with extreme imbalances will quote the best B2B prices on the other side of the market in order to passively rebalance

Hence can infer aggregate dealer imbalances from the market depth at the best bid or ask

Page 23: 1 A Tale of Two Platforms: Dealer Intermediation in the European Sovereign Bond Market CEPR Discussion Paper 6969  Peter Dunne,

© Harald Hau, INSEAD 23

Average Cross Market Spread and Dealer Imbalances

Page 24: 1 A Tale of Two Platforms: Dealer Intermediation in the European Sovereign Bond Market CEPR Discussion Paper 6969  Peter Dunne,

© Harald Hau, INSEAD 24

Ask Side Evidence

Page 25: 1 A Tale of Two Platforms: Dealer Intermediation in the European Sovereign Bond Market CEPR Discussion Paper 6969  Peter Dunne,

© Harald Hau, INSEAD 25

Bid Side Evidence

Page 26: 1 A Tale of Two Platforms: Dealer Intermediation in the European Sovereign Bond Market CEPR Discussion Paper 6969  Peter Dunne,

© Harald Hau, INSEAD 26

Summary

Literature: B2C market have low average transaction quality and high quality dispersion, possibly because of

Lacking customer sophistication (trading errors) Lack of price transparency Price discrimination across customers

European sovereign market High average transaction quality But still high B2C price dispersion Show that inventory constraints are important in explaining B2C

market quality, possibly more than discriminatory pricing B2C market quality better under high risk (incomplete risk pass-

through)