Dealer Behavior Research Articles

Cash Dividends as A Signal to Broker-Dealer Firms

Abstract: Using multivariate regression analysis complemented with simple linear regression, I find that not only do current fiscal year brokerage, clearing, and Exchange expenses affect commission and fees (CE) paid to the broker but also prior brokerage, clearing, and Exchange expenses (BCE). Also, I find that Cash dividends are positively correlated with BCE expenses as well as CE fees. This result is particularly interesting because it implies that brokers can influence commission and fees by affecting the BCE expenses. This might also provide further reasons for agency problems to take place. Overall, this paper contributes to the existing literature on the behavior of brokers and dealers and how they influence the stock market.

What agro-input dealers know, sell and say to smallholder farmers about pesticides: a mystery shopping and KAP analysis in Uganda

BackgroundPesticides can have negative effects on human and environmental health, especially when not handled as intended. In many countries, agro-input dealers sell pesticides to smallholder farmers and are supposed to provide recommendations on application and handling. This study investigates the role of agro-input dealers in transmitting safety information from chemical manufacturers to smallholder farmers, assesses the safety of their shops, what products they sell, and how agro-input dealers abide by laws and recommendations on best practices for preventing pesticide risk situations.MethodsApplying a mixed-methods approach, we studied agro-input dealers in Central and Western Uganda. Structured questionnaires were applied to understand agro-input dealers’ knowledge, attitude and practices on pesticides (n = 402). Shop layout (n = 392) and sales interaction (n = 236) were assessed through observations. Actual behavior of agro-input dealers when selling pesticides was revealed through mystery shopping with local farmers buying pesticides (n = 94).ResultsWhile 97.0% of agro-input dealers considered advising customers their responsibility, only 26.6% of mystery shoppers received any advice from agro-input dealers when buying pesticides. 53.2% of products purchased were officially recommended. Sales interactions focused mainly on product choice and price. Agro-input dealers showed limited understanding of labels and active ingredients. Moreover, 25.0% of shops were selling repackaged products, while 10.5% sold unmarked or unlabeled products. 90.1% of shops were lacking safety equipment. Pesticides of World Health Organization toxicity class I and II were sold most frequently. Awareness of health effects seemed to be high, although agro-input dealers showed incomplete hygiene practices and were lacking infrastructure. One reason for these findings might be that only 55.7% of agro-input dealers held a certificate of competency on safe handling of pesticides and even fewer (5.7%) were able to provide a government-approved up-to-date license.ConclusionThe combination of interviews, mystery shopping and observations proved to be useful, allowing the comparison of stated and actual behavior. While agro-input dealers want to sell pesticides and provide the corresponding risk advice, their customers might receive neither the appropriate product nor sufficient advice on proper handling. In light of the expected increase in pesticide use, affordable, accessible and repeated pesticide training and shop inspections are indispensable.

Electronic Bond Intermediation: Evidence from Corporate Bond ATSs

We examine trading and quoting behavior of dealers in the corporate bond market, using dealer quotation data from two major corporate bond ATSs. We find a clear pecking order of transaction costs in which central dealers offer the lowest transaction costs, followed by high-quoting dealers, then moderate-quoting dealers, and finally non-quoting dealers. We also find that ATSs provide a useful venue for inventory management, especially for dealers who do not possess extensive bilateral trading networks as central dealers. Overall, our study contributes to broadening our understanding of electronic trading channels beyond the traditional voice trading channel and their implications on customer transaction costs in an important OTC market.

The Internal Capital Markets of Global Dealer Banks

<ns3:p>This study uncovers the existence of a trillion-dollar internal capital market that played a central role in the financing of dealer banks during the 2008 Global Financial Crisis. Hand-collecting a novel set of dealer microdata at the subsidiary level, I present the first set of facts on the evolution of interaffiliate loans between U.S. primary dealers and their (primarily foreign) siblings. First, the aggregate size of these dealer internal capital markets quadrupled from $335 billion in 2001 to $1.2 trillion by 2007. Second, 25 percent of total repurchase agreements and 61 percent of total securities lending reported on U.S. primary dealer balance sheets were sourced internally from sibling dealers by year-end 2007. Third, internal securities lending collapsed by 55 percent during the 2008 crisis. These facts suggest that incorporating internal capital market dynamics may be fruitful for future research on dealer behavior and market liquidity.</ns3:p>

PRIOR TRADING OUTCOMES AND SUBSEQUENT PORTFOLIO RISKS: USING SECURITIES DEALER IN TAIWAN AS AN EXAMPLE

This study examines whether the investment behavior of securities dealers is consistent with the predictions of the house money and break-even effects. Using the stock portfolios, dealers hold in Taiwan from 1996 to 2013 as a sample, we test the relationship between trading gains/losses and subsequent changes in portfolio risk. The results show that only gains with low risks, not all gaining situations, cause subsequent risk preferences, and regardless of the size of the trading loss, there is not a significant change in subsequent risk. Controlling dealers’ characteristics, industry competition, and the stock market condition, the evidence shows that the house money effect on dealer behavior exists after earning low-risk profits and does not support the break-even effect. These results are qualitatively unchanged after robustness checks that primarily exclude dealer overconfidence effect and ensure that the risk-taking behavior under low risks results in a decrease in gains and thus not a rational behavior.

The leverage ratio and liquidity in the gilt and gilt repo markets

Market participants argue that a significant unintended consequence of post-crisis regulatory leverage ratio requirements is a reduction in the liquidity of fixed income markets. We assess this claim in the context of the gilt (U.K. government bond) and gilt repo markets over the period 2010 to 2017. We find that gilt repo liquidity worsened during the period when U.K. leverage ratio policy was introduced, and that gilt liquidity worsened conditional on factors such as funding costs and inventory risk. We also find evidence that gilt repo liquidity has become less resilient. However, evidence from heterogeneity in dealer behavior is inconclusive regarding a causal link between leverage ratio requirements and the reduction in market liquidity.

Resilience of Trading Networks: Evidence from the Sterling Corporate Bond Market

We study the network structure and resilience of the sterling investment-grade and high-yield corporate bond markets. Using proprietary, transaction-level data, first we analyse the key properties of the trading networks in these markets. We find that the trading networks exhibit a core-periphery structure where a large number of non-dealers trade with a small number of dealers. Consistent with dealer behaviour in the primary market, we find that trading activity is particularly concentrated for newly issued bonds, where the top three dealers account for 45% of trading volume. Second, we test the resilience of these markets to the failure or paralysis of a key dealer, or to bond rating downgrades. We find that whilst the network structure has been broadly stable and the market broadly resilient around bond downgrades over our 2012–2017 sample period, the reliance on a small number of participants makes the trading network somewhat fragile to the withdrawal of a few key dealers from the market.

Providing liquidity in an illiquid market: Dealer behavior in US corporate bonds

We examine market making behavior of dealers for 55,988 corporate bonds, many of which trade infrequently. Dealers have a substantially higher propensity to offset trades within the same day rather than committing capital for longer periods for riskier and less actively traded bonds. Dealers’ holding periods do not decline with a bond's prior trading activity and in fact are lowest for some of the least active bonds. As a result, cross-sectional estimates of roundtrip trading costs do not increase as prior trading activity declines. Our results suggest that dealers endogenously adjust their behavior to mitigate inventory risk from trading in illiquid and higher risk securities, balancing search and inventory costs in equilibrium such that observed spreads can appear invariant to expected liquidity.

Market-Making Costs and Liquidity: Evidence from CDS Markets

In over-the-counter markets, dealers facilitate trading by becoming market makers. The costs dealers face, including the cost of holding inventory on balance sheet, and the ease, or difficulty, of reducing their positions, determine the degree of liquidity they provide. We provide a stylized model to examine the implications of these costs on dealer behavior and market liquidity. We use the model to guide an empirical study of the single-name credit default swap (CDS) market between 2010-2016. We find that transaction prices between dealers and clients have progressively become more dependent on the inventories of individual dealers rather than on the aggregate inventory across all dealers. We also find that the volume between clients and dealers decreases across all clients, with larger declines for clients that are depository institutions. At the same time, the volume of interdealer trades decreases, dealer inventories decline, and dealers with large inventories are more likely to trade with clients. Our results are consistent with the view that regulatory reforms implemented following the 2007-09 financial crisis increased the cost of holding inventory for dealers, and the cost of interdealer trading.

Market-Making Costs and Liquidity: Evidence from CDS Markets

In over-the-counter markets, dealers facilitate trading by becoming market makers. The costs dealers face, including the cost of holding inventory on balance sheet, and the ease, or difficulty, of reducing their positions, determine the degree of liquidity they provide. We provide a stylized model to examine the implications of these costs on dealer behavior and market liquidity. We use the model to guide an empirical study of the single-name credit default swap (CDS) market between 2010-2016. We find that transaction prices between dealers and clients have progressively become more dependent on the inventories of individual dealers rather than on the aggregate inventory across all dealers. We also find that the volume between clients and dealers decreases across all clients, with larger declines for clients that are depository institutions. At the same time, the volume of interdealer trades decreases, dealer inventories decline, and dealers with large inventories are more likely to trade with clients. Our results are consistent with the view that regulatory reforms implemented following the 2007-09 financial crisis increased the cost of holding inventory for dealers, and the cost of interdealer trading.

Capital Commitment and Illiquidity in Corporate Bonds

ABSTRACTWe study trading costs and dealer behavior in U.S. corporate bond markets from 2006 to 2016. Despite a temporary spike during the financial crisis, average trade execution costs have not increased notably over time. However, dealer capital commitment, turnover, block trade frequency, and average trade size decreased during the financial crisis and thereafter. These declines are attributable to bank‐affiliated dealers, as nonbank dealers have increased their market commitment. Our evidence indicates that liquidity provision in the corporate bond markets is evolving away from the commitment of bank‐affiliated dealer capital to absorb customer imbalances, and that postcrisis banking regulations likely contribute.

Dealer behaviour in the Euro money market during times of crisis

ABSTRACTThis article shows how the recent money market disruptions with elevated counterparty risks and uncertainty about the fundamental value of liquidity influenced the trading behaviour of a key dealer in the Euro money market. The complete trading record in the unsecured segment of the money market for 2007 and 2008 is used to estimate a stylized pricing model, which explicitly accounts for the over-the-counter structure. The empirical results suggest that the market maker learns from order flow, but this information aggregation was increasingly hampered as the crisis unfolded.

Does Trade Reporting Improve Market Quality in an Institutional Market? Evidence from 144a Corporate Bonds

We study the effect of public transaction reporting on trading activity, trade execution costs, and dealer behavior for Rule 144A corporate bonds that are primarily traded by institutional investors. TRACE reporting had no measurable impact on bond turnover, or the dealers’ willingness to hold inventory positions, participate in interdealer trades, or facilitate block transactions. Transaction costs decrease following trade reporting by approximately 10% with large reductions observed for block transactions and bonds with lower dealer competition. Small dealers gain market share and close the trading cost advantage enjoyed by large dealers. Our evidence suggests that even institutional traders benefit from improved transparency, particularly when competition among dealers is weak.

FX Spot and Swap Market Liquidity and the Effects of Window Dressing

We study the joint evolution of foreign exchange (FX) spot and swap market liquidity. Trading in FX swaps exceeds that of spot, yet this market segment has been largely ignored in prior research on liquidity in FX markets. We find strong co-movement in spot and swap market liquidity conditions and a strong link between FX funding and market liquidity, as gleaned from the pricing of both instruments. This link has strengthened over time with changes in dealer behaviour. Some of the largest dealers periodically pull back from pricing FX swaps and wider spreads attract smaller dealers. At the same time, liquidity in FX swaps remains impaired, which leads to adverse illiquidity spillovers to the spot market. Our findings suggest that funding liquidity has become a more important driver of spot market liquidity than it used to be.

Liquidity misallocation in an over-the-counter market

To understand the illiquidity of the over-the-counter market when dealers and traders are in long-term relationships, I develop a framework to study the endogenous liquidity distortions resulting from the profit-maximizing, screening behavior of dealers. The dealer offers the trading mechanism contingent on the aggregate history of his customers summarized by the asset allocation. The equilibrium distortion is type dependent: trade with small surplus breaks down; trade with intermediate surplus may be delayed; trade with large surplus is carried out with a large bid/ask spread but without delay. Because of dealers' limited commitment, the distortions become more severe when the valuation shock is frequent, the valuation dispersion is large or the matching friction to form new relationships is large. Calibrating the model and running a horse race between matching efficiency, trading speed and relationship stability, I found that the liquidity disruption in the market during the recent financial crisis is more consistent with declining matching efficiency of forming trading relationships. The optimal mechanism can be implemented by random quote posting.

The Leverage Ratio and Liquidity in the Gilt and Repo Markets

Market participants have argued that a significant unintended consequence of post-crisis regulatory leverage ratio requirements has been a reduction in the liquidity of fixed income markets. We assess this claim in the context of the gilt (UK government bond) and gilt repo markets. We find that gilt repo liquidity worsened during the period when UK leverage ratio policy was announced, and that gilt liquidity worsened conditional on factors such as funding costs and inventory risk. We also find evidence that gilt repo liquidity has become less resilient. However, evidence from heterogeneity in dealer behaviour is inconclusive regarding a causal link between leverage ratio requirements and the reduction in market liquidity.

Bid-to-cover and yield changes around public debt auctions in the euro area

Earlier research has shown that euro-area primary public debt markets affect secondary markets. We find that more successful auctions of euro area public debt, as captured by higher bid-to-cover ratios, lead to lower secondary-market yields following the auctions. This effect is stronger when market volatility is higher. We rationalize both findings using a simple theoretical model of primary dealer behavior, in which the primary dealers receive a signal about the value of the asset auctioned.

Providing Liquidity in an Illiquid Market: Dealer Behavior in U.S. Corporate Bonds

We examine market making behavior of dealers for 55,988 corporate bonds, many of which trade infrequently. Dealers have a substantially higher propensity to offset trades within the same day rather than committing capital for longer periods for riskier and less actively traded bonds. Dealers’ holding periods do not decline with a bond’s prior trading activity, and in fact are lowest for some of the least active bonds. As a result, cross sectional estimates of roundtrip trading costs do not increase as prior trading activity declines. Our results suggest that dealers endogenously adjust their behavior to mitigate inventory risk from trading in illiquid and higher risk securities, balancing search and inventory costs in equilibrium such that observed spreads can appear invariant to expected liquidity.

Bid-to-Cover and Yield Changes Around Public Debt Auctions in the Euro Area

Earlier research has shown that euro-area primary public debt markets affect secondary markets. We find that more successful auctions of euro area public debt, as captured by higher bid-to-cover ratios, lead to lower secondary-market yields following the auctions. This effect is stronger when market volatility is higher. We rationalize both findings using a simple theoretical model of primary dealer behavior, in which the primary dealers receive a signal about the value of the asset auctioned.

The Behavior of Dealers and Clients on the European Corporate Bond Market: The Case of Multi-Dealer-to-Client Platforms

For the last two decades, most financial markets have undergone an evolution toward electronification. The market for corporate bonds is one of the last major financial markets to follow this unavoidable path. Traditionally quote-driven (i.e., dealer-driven) rather than order-driven, the market for corporate bonds is still mainly dominated by voice trading, but a lot of electronic platforms have emerged. These electronic platforms make it possible for buy-side agents to simultaneously request several dealers for quotes, or even directly trade with other buy-siders. The research presented in this paper is based on a large proprietary database of requests for quotes (RFQ) sent, through the multi-dealer-to-client (MD2C) platform operated by Bloomberg Fixed Income Trading, to one of the major liquidity providers in European corporate bonds. Our goal is (i) to model the RFQ process on these platforms and the resulting competition between dealers, and (ii) to use our model in order to implicit from the RFQ database the behavior of both dealers and clients on MD2C platforms.