Institutional Trading Costs in European Corporate Bond Markets

Abstract

In the past, researchers have extensively studied transaction costs in equity markets and found that implicit trading costs are economically significant. In contrast, few studies analyze transaction costs for institutional bond trades. Given the importance of worldwide bond markets, this seems surprising. The strong increase in the amount outstanding of euro-denominated bonds after the introduction of the euro exhibited in Figure 4.1 shows the growing importance of European corporate bond markets. But compared to the US, with an amount outstanding of $ 4.9 trillion,¹¹⁸ the European market is still small. Even though the issuing activity was boosted by the introduction of the euro, the marketability and therefore liquidity of these issues is unexplored. In addition, the market for euro-denominated corporate bonds is still very opaque compared to the US market where the National Association of Securities Dealers (NASD) introduced its Trade Reporting and Compliance Engine (TRACE) on July 1, 2002 to publicly report OTC-transactions in corporate bonds. Edwards, Harris, and Piwowar (2004) and Bessembinder, Maxwell, and Venkataraman (2005) show that the dissemination of information on completed trades leads to a decrease in trading costs and thereby to an increase in liquidity.¹¹⁹ The European market does not provide any post trade information to its investors and only the parties involved have knowledge on the existence of the trade.¹²⁰ As a whole, the European market is comparable to the US market before the introduction of TRACE in terms of transparency, but it is still less mature.

The amount outstanding for the US market is an estimate by The Bone Market Association (2005).

See Edwards, Harris, and Piwowar (2004), p. 26 and Bessembinder, Maxwell, and Venkataraman (2005), pp. 32–24.

An exception are trades on electronic multiple dealer systems in the customer-dealer market, some of which disseminate information on trade to the systm’s participants. See The Bond Market Association (2005), p. 9.