Are Prices in OTC Transactions Different from Exchanges? The Case of - PowerPoint PPT Presentation

Motivation Data Price Comparison Determinants Conclusion Are Prices in OTC Transactions Different from Exchanges? The Case of the Bund de Roure, Moench, Pelizzon and Schneider Frankfurt School of Finance, Bundesbank, Goethe University, Scuola Normale Pisa c.deoure@fs.de August 10, 2016

Motivation Data Price Comparison Determinants Conclusion Motivation German Bund is the reference market in the Euro area and considered its most liquid market; This conclusion is mainly based on futures market. What about its underlying? The cash market is only observed through interdealer platforms (as MTS), where price discrimination does not occur; However, the Bund cash market is mainly OTC; How does the Bund OTC market compare to exchange? Are trades in interdealer platforms comparable to OTC? Note: I use the term Bund for Bunds (10 and 30 years) and Bolbs (5 years).

Motivation Data Price Comparison Determinants Conclusion Average OTC price versus MTS DE0001135341 103 ● ● ● ● ● ●● 102 ● ●● Price (EUR per 100EUR face value) ●● ● ●● 101 ● ● ●●● ●● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ●● ●● 100 ● ● ● ● ● ● ● ●● ● ● ● ● ● ● 99 ● ● ● ● 98 ● 97 Jan 01 Jan 15 Feb 01 Feb 15 Mar 01 Mar 15 Apr 01 Candle: min best bid, mean of best bid, mean of best ask, max best ask quote

Motivation Data Price Comparison Determinants Conclusion Motivation: The Bund Cash Market However, the banks in our sample traded Bunds 55,554 times OTC in 2008 26% (14,601) of these transactions were realized outside the bid-ask band in MTS

Motivation Data Price Comparison Determinants Conclusion Motivation: The Bund Cash Market Large fragmentation (virtually every European bank hold Bunds), decentralized (37 dealers in the primary market) and well-established repo market increase costs of taking and reversing positions (Bundesbank 2007, Upper and Werner 2007) Bulk of trading and price discovery takes place in the futures market Daily turnover cash market 19 billion e vs. 70 billion e in the futures market (Finanzagentur)

Motivation Data Price Comparison Determinants Conclusion Data MTS (about 2% of total market based on turnover) Largest interdealer platform Few trades but very active limit order book of standing executable quotes Data: best-bid /best-ask, turnover BaFin (about 15% of total market based on turnover) All fixed income trades of 27 banks between Jan, 1st and Dec, 31st 2008; Focus on OTC trades in own account Every trade is reported once by the initiator Data: price, volume, initiator, counterparty, trade sign (buy/sell)

Motivation Data Price Comparison Determinants Conclusion Summary Statistics pre-Lehman post-Lehman 5y 10y 30y 5y 10y 30y #bonds 8 20 9 8 20 9 OTC #trades 11,641 32,401 2,882 3,153 6,697 1,064 avg volume (million e ) 8.94 8.03 6.95 5.10 6.70 6.31 monthly turnover (million e ) 11,200 28,200 1,720 7,300 19,200 3,360 MTS #trades 2,749 6,414 1,793 308 649 490 avg volume (million e ) 7.74 6.80 3.80 8.54 7.58 3.95 monthly turnover (million e ) 295 254 106 80 65 80 avg bid-ask spread ( e ) 0.043 0.045 0.388 0.200 0.289 0.949 avg quote size (million e ) 15.6 15.1 4.4 10.3 9.8 4.2

Motivation Data Price Comparison Determinants Conclusion Are OTC trades outside the bid-ask band from MTS? Comparing to best bid d bid = bestbid − p OTC Comparing to best ask d ask = p OTC − bestask If d bid > 0 or d ask > 0 trade is executed outside bid-ask band.

Motivation Data Price Comparison Determinants Conclusion Are OTC trades outside the bid-ask band from MTS? Full Sample 15 15 10 10 Density Density 5 5 0 0 -.6 -.4 -.2 0 .2 -.8 -.6 -.4 -.2 0 .2 d_ask d_bid (a) d ask = p OTC − bestask (b) d bid = bestbid − p OTC

Motivation Data Price Comparison Determinants Conclusion Are OTC trades outside the bid-ask band from MTS? Comparable size, before Lehman 15 15 10 10 Density Density 5 5 0 0 -.6 -.4 -.2 0 .2 -.8 -.6 -.4 -.2 0 .2 d_ask d_bid (a) d ask = p OTC − ask best (b) d bid = bid best − p OTC Comparable size, after Lehman 6 5 4 4 Density 3 Density 2 2 1 0 0 -.6 -.4 -.2 0 .2 -.8 -.6 -.4 -.2 0 .2 d_ask d_bid (c) d ask = p OTC − ask best (d) d bid = bid best − p OTC

Motivation Data Price Comparison Determinants Conclusion What drives trades outside the bid-ask band? However, for every trade outside the bid-ask band there is someone doing a good and someone a bad job. What drives trades outside the bid-ask band?

Motivation Data Price Comparison Determinants Conclusion Define Good/Bad Buys, Good/Bad Sells MTS MTS best bid best ask premium discount price Good Buys Bad Buys Bad Sells Good Sells

Motivation Data Price Comparison Determinants Conclusion Summary Statistics pre-Lehman post-Lehman 5y 10y 30y 5y 10y 30y trades inside spread 67.79% 64.14% 75.18% 87.44% 86.90% 89.66% Good Buys 7.83% 10.30% 9.30% 3.55% 4.88% 4.61% Bad Sells 12.44% 11.73% 6.18% 5.93% 5.44% 2.44% Bad Buys 5.94% 6.60% 3.30% 1.49% 2.57% 1.41% Good Sells 6.00% 7.23% 6.04% 1.59% 3.21% 1.88%

Motivation Data Price Comparison Determinants Conclusion Estimation Extensive margin: what is the probability that a bank does a good/bad trade? (our focus today) Instensive margin: what are the drivers of the OTC premium?

Motivation Data Price Comparison Determinants Conclusion Probit Good Buy, below best-bid (Marg. Effect at Means) Volume 0.004*** 0.002*** 0.002** 0.001 0.003 (0.001) (0.001) (0.001) (0.001) (0.003) Bid-Ask Spread -0.529*** -0.491*** -0.645*** -0.504*** (0.032) (0.063) (0.124) (0.080) After-Lehman -0.011*** (0.001) Volume*After-Lehman 0.005*** (0.001) Bid-Ask Spread*After-Lehman 0.003*** (0.010) Dealer 0.013 (0.052) Volume*Dealer -0.002 (0.003) Bid-Ask Spread*Dealer 0.024 (0.051) Interdealer -0.357*** (0.098) Volume*Interdealer 0.023*** (0.007) Bid-Ask Spread*Interdealer -0.757 (0.524) Security FE yes yes yes yes yes Bank FE no no yes yes no Time FE no no weekly no weekly Pseudo R 2 0.0109 0.0456 0.0574 0.0551 0.0517 # Obs 55552 55552 55541 55541 55552

Motivation Data Price Comparison Determinants Conclusion Probit Bad Sell, below best-bid (Marg. Effect at Means) Volume 0.012*** 0.011*** 0.008** 0.008** 0.003 (0.001) (0.001) (0.003) (0.004) (0.001) Bid-Ask Spread -0.329*** -0.266*** -0.387*** -0.293*** (0.083) (0.025) (0.035) (0.023) After-Lehman -0.028 (0.024) Volume*After-Lehman -0.001 (0.002) Bid-Ask Spread*After-Lehman 0.177*** (0.024) Dealer -0.266*** (0.039) Volume*Dealer 0.014*** (0.002) Bid-Ask Spread*Dealer 0.065 (0.055) Interdealer 0.174** (0.074) Volume*Interdealer -0.009* (0.005) Bid-Ask Spread*Interdealer -0.120 (0.112) Security FE yes yes yes yes yes Bank FE no no yes yes no Time FE no no weekly no weekly Pseudo R 2 0.0436 0.0694 0.1367 0.1317 0.1156 # Obs 55477 55477 55477 55477 55477

Motivation Data Price Comparison Determinants Conclusion Probit Bad Buy, above best-ask (Marg. Effect at Means) Volume 0.013*** 0.012*** 0.009*** 0.010*** 0.005*** (0.001) (0.001) (0.002) (0.002) (0.002) Bid-Ask Spread -0.301*** -0.293*** -0.347*** -0.265*** (0.042) (0.005) (0.062) (0.039) After-Lehman -0.022 (0.022) Volume*After-Lehman -0.002 (0.001) Bid-Ask Spread*After-Lehman 0.101*** (0.035) Dealer -0.162*** (0.038) Volume*Dealer 0.008*** (0.002) Bid-Ask Spread*Dealer -0.085 (0.063) Interdealer 0.457*** (0.096) Volume*Interdealer -0.027*** (0.006) Bid-Ask Spread*Interdealer -0.427** (0.216) Security FE yes yes yes yes yes Bank FE no no yes yes no Time FE no no weekly no weekly Pseudo R 2 0.0565 0.0788 0.1388 0.1325 0.1176 # Obs 55452 55452 55365 55365 55452

Motivation Data Price Comparison Determinants Conclusion Probit Good Sell, above best-ask (Marg. Effect at Means) Volume -0.002* -0.004*** -0.003** -0.000 -0.002 (0.001) (0.001) (0.001) (0.002) (0.003) Bid-Ask Spread -0.551*** -0.666*** -0.787*** -0.78*** (0.028) (0.094) (0.168) (0.117) After-Lehman 0.154*** (0.016) Volume*After-Lehman -0.011*** (0.001) Bid-Ask Spread*After-Lehman 0.158 (0.115) Dealer 0.007 (0.056) Volume*Dealer -0.001 (0.003) Bid-Ask Spread*Dealer 0.142*** (0.047) Interdealer -0.396* (0.182) Volume*Interdealer 0.022* (0.012) Bid-Ask Spread*Interdealer 0.356* (0.193) Security FE yes yes yes yes yes Bank FE no no yes yes no Time FE no no weekly no weekly Pseudo R 2 0.0109 0.0414 0.0546 0.0508 0.0486 # Obs 55552 55552 55541 55541 55541

Motivation Data Price Comparison Determinants Conclusion Conclusion OTC prices can differ substantially from interdealer platform Trade size and market liquidity drive trades outside the bid-ask band We find evidence for price differentiation: Interdealer trade is less likely to be good and more likely to be 1 bad Dealer/Non-dealer trade: less likely to be bad 2 Lehman increases bid-ask spread and reduces the number of trades outside bid-ask band