Price Dispersion in OTC Markets: A New Measure of Liquidity

Jankowitsch, Rainer and Nashikkar, Amrut and Subrahmanyam, Marti G. (2010) Price Dispersion in OTC Markets: A New Measure of Liquidity. Journal of Banking and Finance, 35 (2). pp. 343-357. ISSN 0378-4266


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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 devia- tion 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 tofstudy liquidity effects since, from October 2004 onwards, all OTC transactions in this marketfhave to be reported to a common database known as the Trade Reporting and CompliancefEngine (TRACE). Furthermore, market-wide average price quotes are available from MarkitGroup 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. Wefshow that our new measure is indeed related to liquidity by regressing it on commonly-usedfliquidity 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. (authors' abstract)

Item Type: Article
Additional Information: To see the final version of this paper please visit the publisher's website. Access to the published version may require a subscription.
Keywords: liquidity / corporate bonds / market microstructure / OTC markets
Classification Codes: JEL G 12
Divisions: Departments > Finance, Accounting and Statistics > Finance, Banking and Insurance
Version of the Document: Accepted for Publication
Variance from Published Version: Minor
Depositing User: Dissertation Administrator
Date Deposited: 28 Mar 2011 09:15
Last Modified: 26 Apr 2015 20:37
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