survey-of-microstructure-of-fixed-income-market
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survey-of-microstructure-of-fixed-income-market
JOURNAL OF FINANCIAL AND QUANTITATIVE ANALYSIS Vol. 55. No. 1. Feb. 2020. pp. 1-45 COPYRIGHT 2019. MICHAEL G. FOSTER SCHOOL OF BUSINESS. UNIVERSITY OF survey-of-microstructure-of-fixed-income-marketF WASHINGTON. SEATTLE, WA 98195 đoi: 10.1017/S0022109019000231A Survey of the Microstructure of Fixed-Income MarketsHendrik Bessembinder , Chester spatt, andKumar Venkataraman*AbstractIn this article, we survey the literature that studies fixed-income trading Riles and outcomes. including Treasury s survey-of-microstructure-of-fixed-income-marketecurities, corporate and municipal bonds, and structured credit products. We compare and contrast the microstructure and regulation of fixed-income masurvey-of-microstructure-of-fixed-income-market
rkets with equity markets. We highlight the nature of over-the-counter trading in the face of search costs and the associated slow evolution of electrJOURNAL OF FINANCIAL AND QUANTITATIVE ANALYSIS Vol. 55. No. 1. Feb. 2020. pp. 1-45 COPYRIGHT 2019. MICHAEL G. FOSTER SCHOOL OF BUSINESS. UNIVERSITY OF survey-of-microstructure-of-fixed-income-markettrading costs, and the important roles dealer networks and limited transparency play. We also highlight unresolved issues.I.IntroductionFinancial markets create and transact a broad set of fixed-income instruments. characterized by contracts that specify the amount and timing of promised payments. W survey-of-microstructure-of-fixed-income-marketith a few exceptions to be noted, fixed-income instruments trade in dealer-oriented over-the-counter (OTC) search markets that differ significantly frsurvey-of-microstructure-of-fixed-income-market
om the more widely-studied markets for equity instruments.Treasury securities issued by central governments are in many ways the simplest fixed-incomeJOURNAL OF FINANCIAL AND QUANTITATIVE ANALYSIS Vol. 55. No. 1. Feb. 2020. pp. 1-45 COPYRIGHT 2019. MICHAEL G. FOSTER SCHOOL OF BUSINESS. UNIVERSITY OF survey-of-microstructure-of-fixed-income-marketons as well as municipalities constitute one of the largest segments of the fixed-income markets. In addition, fixed-income markets trade structured products, which arc created by repackaging existing loans. Examples include mortgage-backed securities (MBS), cither with (agency MBS) or without (priv survey-of-microstructure-of-fixed-income-marketatelabel MBS) the implicit backing of semi-government agencies; asset-backed securities (ABS). which are secured by assets such as auto loans or credisurvey-of-microstructure-of-fixed-income-market
t card debt;*Bcsscmbindcr (corresponding author), hb@asu.edu, w. p. Carey School of Business. Arizona State University; Spatt. cspatt@cniu.edu. TepperJOURNAL OF FINANCIAL AND QUANTITATIVE ANALYSIS Vol. 55. No. 1. Feb. 2020. pp. 1-45 COPYRIGHT 2019. MICHAEL G. FOSTER SCHOOL OF BUSINESS. UNIVERSITY OF survey-of-microstructure-of-fixed-income-marketsity. Wc thank Jack Bao. Jennifer Conrad (the editor). Darrell Duftic. Michael Fleming. Terry Hendershott. Edie Hotchkiss. David Krein. Amar Kuchinad. Ananth Madhavan. Artem Neklyudov. Paul Schultz, and Alex Sedgwick fortheir valuable comments.2 Journal of Financial and Quantitative Analysisand pack survey-of-microstructure-of-fixed-income-marketages of bank loans. Fixed-income markets also include collateralized debt obligations (CDOs). which are created from structured products by dividing csurvey-of-microstructure-of-fixed-income-market
ash-flow promises into various “tranches.”1In general, fixed-income trading has been the focus of less research attention as compared to equity marketJOURNAL OF FINANCIAL AND QUANTITATIVE ANALYSIS Vol. 55. No. 1. Feb. 2020. pp. 1-45 COPYRIGHT 2019. MICHAEL G. FOSTER SCHOOL OF BUSINESS. UNIVERSITY OF survey-of-microstructure-of-fixed-income-marketussed further in Section III.A). Recent years have seen an increase in research, both theoretical and empirical, focused on fixed-income trading. This article reviews and summarizes the key issues and many of the important studies, while laying out directions for potential future research.II.Fixed-I survey-of-microstructure-of-fixed-income-marketncome versus Equity MarketsFixed-income and equity markets share important common features. Each facilitates price discovery and the completion of trasurvey-of-microstructure-of-fixed-income-market
nsactions in financial assets. Investors seeking to buy and to sell do not necessarily arrive simultaneously in these markets, so intermediaries emergJOURNAL OF FINANCIAL AND QUANTITATIVE ANALYSIS Vol. 55. No. 1. Feb. 2020. pp. 1-45 COPYRIGHT 2019. MICHAEL G. FOSTER SCHOOL OF BUSINESS. UNIVERSITY OF survey-of-microstructure-of-fixed-income-marketprice risk on the positions entered to facilitate transactions. Because the value of both fixed-income and equity instruments depends on mar-ketwide variables, such as central bank policy and macroeconomic growth, as well as issuer-specific outcomes, and because some participants may have better acc survey-of-microstructure-of-fixed-income-marketess to such information than others, risks attributable to asymmetric information arise in both markets. Microstructure theory broadly applied therefosurvey-of-microstructure-of-fixed-income-market
re implies that the costs of demanding immediate trade execution in both equity and fixed-income markets should depend on return volatility, customer JOURNAL OF FINANCIAL AND QUANTITATIVE ANALYSIS Vol. 55. No. 1. Feb. 2020. pp. 1-45 COPYRIGHT 2019. MICHAEL G. FOSTER SCHOOL OF BUSINESS. UNIVERSITY OF survey-of-microstructure-of-fixed-income-market-Income and Equity MicrostructuresDespite these similarities in the underlying economic issues, fixed-income microstructure differs significantly from that of the equity markets. Although most equity trading has migrated in recent years to electronic limit order markets. with the exception of U.S. T survey-of-microstructure-of-fixed-income-marketreasury instruments and to-be-announced MBS (TB/\ MBS. discussed further later), relatively little fixed-income trading occurs on electronic platformssurvey-of-microstructure-of-fixed-income-market
.2 For example, a recent industry report estimated that just 19% of U.S. investment-grade coiporatc bond trading was electronically facilitated, mostlJOURNAL OF FINANCIAL AND QUANTITATIVE ANALYSIS Vol. 55. No. 1. Feb. 2020. pp. 1-45 COPYRIGHT 2019. MICHAEL G. FOSTER SCHOOL OF BUSINESS. UNIVERSITY OF survey-of-microstructure-of-fixed-income-markettrading-continues-growth-trcnd (July 28. 2016). Hendershott and Madhavan (2015) describe trading on the basis of indicative RFỌs on MarkctAxcss. Clients select the number of dealers to be queried for'See the Financial Industry Regulatory Authority’s (FINRA) 2017 TRACE Fact Book for detailed definiti survey-of-microstructure-of-fixed-income-marketons of debt instruments (http://www.finra.org/sites/default/files/2017-ưace-fact-book.pdf)-’Abudy and Wohl (2018) examine Tel Aviv Stock Exchange datasurvey-of-microstructure-of-fixed-income-market
in 2014. where corporate bonds trade in a consolidated limit order book market structure, reporting that the market is liquid with narrow spreads andJOURNAL OF FINANCIAL AND QUANTITATIVE ANALYSIS Vol. 55. No. 1. Feb. 2020. pp. 1-45 COPYRIGHT 2019. MICHAEL G. FOSTER SCHOOL OF BUSINESS. UNIVERSITY OF survey-of-microstructure-of-fixed-income-marketuld be submitted. At that lime, all quotes are revealed to the client. If satisfied. the client can contact the dealer submitting the best quote for execution. Hendershott and Madhavan report that RFỌ usage is greatest for recently issued, investment-grade, large-issue-size bonds. 'Quotations in equ survey-of-microstructure-of-fixed-income-marketity markets are firm, in that the submission by another market participant of an opposite-direction order with a sufficiently aggressive limit price gsurvey-of-microstructure-of-fixed-income-market
enerates an immediate trade execution. In contrast, fixed-income quotes are typically indicative rather than firm commitments. Fixed-income trading isJOURNAL OF FINANCIAL AND QUANTITATIVE ANALYSIS Vol. 55. No. 1. Feb. 2020. pp. 1-45 COPYRIGHT 2019. MICHAEL G. FOSTER SCHOOL OF BUSINESS. UNIVERSITY OF survey-of-microstructure-of-fixed-income-marketn the same platforms. The lack of electronically executable quotations has largely kept high-frequency trading (HFT) firms from establishing themselves as major players in the fixed-income markets. As a consequence, most liquidity provision in fixed-income markets continues to rely on dealer firms, survey-of-microstructure-of-fixed-income-marketwith little direct access by public orders.* 4 The situation is analogous to the design of the National Association of Securities Dealers Automated Qusurvey-of-microstructure-of-fixed-income-market
otations (NASDAQ) equity markets, before the establishment of order-handling rules 2 decades ago.Nevertheless, the electronic facilitation of bond traJOURNAL OF FINANCIAL AND QUANTITATIVE ANALYSIS Vol. 55. No. 1. Feb. 2020. pp. 1-45 COPYRIGHT 2019. MICHAEL G. FOSTER SCHOOL OF BUSINESS. UNIVERSITY OF survey-of-microstructure-of-fixed-income-marketies on electronic communication. Platforms that allow for direct customcr-to-customer (or “all-to-all”) trading have been introduced to corporate bond markets, though their share of trading remains low. Furthermore, some liquidity providers now respond to corporate bond RFQs for trades below certain survey-of-microstructure-of-fixed-income-market size thresholds using algorithms rather than human traders (https://www.grccnwich.com/prcss-rclcasc/robots-have-cntercd-corporatc-bond-markct).The eqsurvey-of-microstructure-of-fixed-income-market
uity markets are highly transparent, as prices and quantities for completed trades (“post-trade transparency”) as well as the best available bid and aJOURNAL OF FINANCIAL AND QUANTITATIVE ANALYSIS Vol. 55. No. 1. Feb. 2020. pp. 1-45 COPYRIGHT 2019. MICHAEL G. FOSTER SCHOOL OF BUSINESS. UNIVERSITY OF survey-of-microstructure-of-fixed-income-market fixed-income markets arc relatively opaque, as quotations are distributed to only some market participants. The various market venues that trade equities are integrated by both regulation and competition. Regulation NMS (National Market System) in particular requires that no equity trade of limited survey-of-microstructure-of-fixed-income-market size be executed at a price worse than the best electronically accessible quotation on any exchange. Fixed-income markets are not subject to a similasurvey-of-microstructure-of-fixed-income-market
r regulation. Although, as discussed further in Section VI, brokerage firms are subject to a duty of best execution.MarketAxess reportedly holds an 85Gọi ngay
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