Trade price clustering in the corporate bond market

Abstract

PurposeIn this paper, the authors document the existence of price clustering in the US corporate bond market.Design/methodology/approachUsing a sample of 8,422,593 corporate bond trades in 2014, the authors find that over 18% (1,522,284 trades) of all bond trades end in a clustered price, defined as a price ending in 00, 25, 50, or 75.FindingsOverall, the authors find that both bond rating category and risk, as measured by standard deviation of prices, play a role in price clustering; speculative grade bonds account for the majority of clustered prices. Clustered prices are more likely to have higher coupon rates, higher prices, and higher standard deviations of price than bonds with non-clustered prices. Regardless of size, both buy and sell dealer trades with customers (relative to interdealer trading) lead to an increase in price clustering. Dealers appear to use clustered prices when purchasing from and selling to institutions and, therefore, may use a clustered price to insulate themselves from the risk of asymmetric information. Additionally, the prevalence of clustered prices for retail-sized dealer sell trades suggests that dealers exercise dealer power over retail-sized traders.Originality/valueThis paper contributes to the literature on price clustering by examining trade price clustering of corporate bonds. It is different from previous papers on price clustering in equities. Given that bonds tend to be priced off of yield, it is unusual that trade prices cluster. It also demonstrates what kind of bonds cluster and with which customers dealers trade at clustered prices. It parallels other research in demonstrating dealer power over retail-sized traders.