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HomeBankDo bigger bond trades value extra to execute? – Financial institution Underground

Do bigger bond trades value extra to execute? – Financial institution Underground


Gábor Pintér

Are bigger trades kind of costly to execute in bond markets than smaller trades? That is an outdated and unsettled query within the literature on monetary markets. The purpose of this weblog put up is to supply novel solutions to this query, based mostly on our latest analysis utilizing transaction-level knowledge from the UK authorities and company bond markets, over the interval 2011–17.[1]

What does earlier analysis say concerning the size-cost relation?

The present empirical proof reveals that bigger trades incur decrease buying and selling prices (‘dimension low cost’) in numerous over-the-counter (OTC) monetary markets reminiscent of the marketplace for authorities bonds and company bonds amongst many others. The scale low cost is per theories of bilateral buying and selling with imperfect competitors. They predict that bigger trades get extra beneficial costs as a result of sellers’ bargaining energy decreases within the dimension of their purchasers, and bigger purchasers are likely to commerce bigger quantities. Nevertheless, theories of data asymmetry and stock imbalances predict ‘dimension penalty’, in that bigger trades could be executed at much less beneficial costs. That’s due to sellers’ concern of being adversely chosen by the knowledgeable purchasers or due to sellers’ further stock prices when managing a bigger commerce. To sum up, theories of bargaining give contrasting predictions on the size-cost relation in comparison with theories of informational asymmetry and stock imbalances. This has generated some rigidity within the literature.

New proof on the size-cost relation

Our analysis reconciles a few of this rigidity on this literature by offering a brand new decomposition of the size-cost relation. Particularly, we estimate i) how buying and selling prices range throughout purchasers (‘cross-client variation’) and ii) how buying and selling prices range throughout trades of various sizes for a similar consumer (‘within-client variation’). We’re in a position to do that decomposition as a result of our distinctive dataset comprises the identities of counterparties for nearly all secondary market transactions within the UK bond markets. This permits us to tell apart between client-specific traits (reminiscent of merchants’ dimension and kind) and transaction-specific traits (reminiscent of commerce dimension) in figuring out buying and selling prices.

We use easy panel knowledge strategies, whereby we regress purchasers’ buying and selling prices on commerce sizes and numerous management variables, utilizing all out there client-dealer trades. We compute purchasers’ buying and selling prices (measured in foundation factors) because the distinction between the transaction costs and a benchmark worth (measured as the common transaction worth). We discover that bigger trades get decrease buying and selling prices than smaller trades, thereby corroborating the earlier literature on the ‘dimension low cost’. Nevertheless, we discover that buying and selling prices enhance in commerce dimension as soon as we management for purchasers’ identities, producing a ‘dimension penalty’. These two findings are illustrated in Chart 1, which reveals the connection between commerce dimension and buying and selling prices in authorities bonds from two completely different mannequin specs. 

Chart 1: The relation between commerce dimension and buying and selling prices within the gilt market (2011–17)

The left panel of Chart 1 plots the fitted linear regression line from a pooled regression of buying and selling prices on commerce dimension. The trade-level regression reveals that bigger trades incur decrease buying and selling prices, per the findings of dimension low cost in different OTC markets. Our novel contribution is to isolate the within-client variation within the size-cost relation. The correct panel of Chart 1 reveals the regression line after eradicating the client-specific common from buying and selling prices and commerce dimension, giving rise to a dimension penalty. This means that the dimensions low cost is pushed by the cross-client variation, as bigger purchasers with extra pricing energy are in a position to acquire decrease buying and selling prices. The scale penalty is pushed by the within-client variation of the identical dealer dealing with larger buying and selling prices when managing bigger trades.

What drives the dimensions penalty?

Our analysis additionally offers evaluation of the determinants of the dimensions penalty in additional element. For instance, we present that the dimensions penalty is bigger for hedge funds and asset managers, and it’s smaller for pension funds, international central banks and insurance coverage corporations. Furthermore, the dimensions penalty, confronted by hedge funds and asset managers, is bigger throughout informationally intensive intervals reminiscent of buying and selling days that coincide with the arrival of huge macroeconomic shocks. In distinction, the dimensions penalty confronted by different purchasers is analogous throughout buying and selling days regardless of the magnitude of macroeconomic shocks on the time. As well as, the dimensions penalty is bigger in company bonds than in authorities bonds, and, importantly, this distinction is extra pronounced amongst hedge funds and asset managers in comparison with different purchasers.

Our analysis additionally compares the dimensions penalty throughout the UK gilt and US Treasury markets. Provided that the US Treasury market is bigger, deeper and extra liquid than the UK gilt market, each inventory-based theories and information-based theories would predict a smaller dimension penalty in US Treasuries. The outcomes are per these predictions: the dimensions penalty in US Treasuries is estimated to be about 3 times as small as in UK gilts.

Taken collectively, these outcomes are interpreted as proof that information-based explanations contribute to the heterogeneity in dimension penalty. To the extent that hedge funds and asset managers usually tend to commerce on data than different purchasers, the differential diploma of dimension penalty throughout consumer varieties, is per theories of uneven data. These theories predict that bigger trades (particularly these of hedge funds) usually tend to be informational, in order that sellers rationally cost larger execution prices on these trades in an effort to be compensated for adversarial choice threat.

Why does the size-cost relation matter?

There are numerous dimensions of market liquidity such because the bargaining energy and steadiness sheet constraints of sellers, the worth affect of knowledgeable buying and selling amongst others. Observing the identities of purchasers (and their transaction costs) in bond markets may also help disentangle these completely different dimensions of liquidity and provides us a greater understanding on how costs are decided in OTC markets on the whole.

For instance, if one goals to study concerning the position of sellers’ market energy in shaping market liquidity, then one might examine the transaction costs of various kinds of purchasers (eg small retail purchasers versus massive asset managers). If, alternatively, one goals to grasp the worth affect of knowledgeable buying and selling, then one ought to examine the transaction costs for small and bigger trades initiated by the identical good investor (eg a star hedge fund). Our outcomes present that each channels appear to contribute to variation in bond market spreads.


Gábor Pintér works within the Centre For Central Banking Research inside the Financial institution.

If you wish to get in contact, please e mail us at bankunderground@bankofengland.co.uk or go away a remark beneath.

Feedback will solely seem as soon as authorized by a moderator, and are solely printed the place a full identify is equipped. Financial institution Underground is a weblog for Financial institution of England workers to share views that problem – or assist – prevailing coverage orthodoxies. The views expressed listed below are these of the authors, and should not essentially these of the Financial institution of England, or its coverage committees.


[1] The outcomes could due to this fact not be consultant of present market liquidity and dynamics.

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